When it comes to choosing suitable investments for the portfolio, an average Indian investor is spoilt for choice. In the Indian markets, there are various investment products available across the risk-return spectrum and tenures. In the fixed-income space, for investors looking for low-risk and short tenure instruments, overnight and liquid funds can be a good investment choice. These are considered by many as short-term cash management solutions.
What are overnight funds?
Overnight funds, as a category of mutual fund schemes, were formally introduced by the SEBI as a separate category of funds in 2018. These funds primarily invest in securities that mature in one day, mainly referred to as the triparty repo trades for which the Clearing Corporation of India is the central counterparty. Additionally, overnight funds can also choose to invest in other one-day instruments as well such as one-day commercial paper. From a risk perspective, overnight funds are considered the least risky since they give the money back in one day. This means that they carry no interest rate risk. Withdrawals from overnight funds is simple and easy since these funds do not have an exit load. It is important to note that overnight funds charge 4 basis points to 81 basis points as expense ratio.
What are liquid funds?
Liquid funds usually invest in securities maturing in up to 91 days. These generally include certificates of deposits, commercial papers, treasury bills and other instruments that mature within a stipulated time period. Similar to overnight funds, liquid funds too are considered low-risk schemes. However, they are considered riskier than overnight funds since they carry an element of interest rate risk and credit risk. Until recently, there was no exit load imposed on liquid funds. However, from October 20, 2019, SEBI introduced graded exit loads. The load is 0.007 per cent on the first day and falls to 0.0045 per cent on the sixth day from the date of investment. From the seventh day onwards there is no exit load. The main purpose behind the introduction of exit loads on investments in liquid funds was to shift the very short-term money to overnight funds. From an expense perspective, liquid funds levy 5 basis points to 97 basis points as expense ratio.
Investors can use liquid funds to park their surplus cash for the short-term, usually in excess of seven days. Overnight funds can be used to park surplus cash for the very short-term.