Liquid Funds - Simplified
This article is Part 2 of short term bond funds category. This article describes investment objectives, parameters to be looked upon & in what circumstances it should be avoided.
Estimated time read - 5 minutes
Brief –
The liquid fund forms a part of sub category of short term debt mutual funds. The previous article, described Overnight fund which is also a sub category under short term debt mutual fund.
In case you want to refresh the mutual fund categories you find them here.
Liquid Funds -
Liquid funds as the name implies have higher liquidity, as they invest in instruments which have maturity lower then 91 days which is mandated by SEBI regulations. Liquid fund as a category holds Rs. Almost Rs. 6 lakh crores of AUM (Source – AMFI). But most investors fail to quantify & compare the pros & cons of each AMC liquid fund. This article will delve deeper into liquid funds & try to compare various liquid funds.
Investment Objectives –
They are mandated by SEBI regulation to invest only in debt securities which have maturities less than 91 days.
Suitable for which type of goals? –
1. Short term goals with tenure less than a year
2. Money to be parked temporarily which is to be invested in other schemes via systematic transfer plan.
3. If one receives lumpsum, one can invest in liquid fund if worried at investing at current levels & start Systematic Transfer Plan (STP) to transfer funds from liquid scheme to desired scheme.
Risk levels of liquid funds –
These funds have varying level of risks ranging from medium to slightly higher risk profile as they hold corporate securities along with sovereign. As it invests in some risky securities, they also earn higher returns than overnight funds, which yield returns even below bank savings account deposit rates which I described here. But the alpha (extra returns) generated won’t suffice for longer term goals.
Parameters to be looked upon
1. Portfolio of securities held –
As these companies invest in risky securities, it becomes necessary to look at the portfolio of securities held.
2. Credit rating reports of securities held –
If one has shortlisted a fund, then one should try reading credit rating reports, which summarize company’s business & outlook of the company. One should regularly track it because, a company rated AAA (very less probability of default) can be rated D (defaulted on repayment) within a span of a month.
3. Fund manager & his experience –
The fund manager experience can be found on AMC website easily. It is an important factor as it is the fund manager who takes the decisions in which securities the funds should be invested in.
4. Asset management company(AMC) past track record –
The AMC name also matters. Recently, Franklin Templeton’s 6 six schemes were shut for withdrawals, which has created confidence crisis for the AMC. There were similar shorter instances with other AMC’s too, but were covered up by the companies without press gathering much attention about it.
5. Expense ratio & Asset Under Management in the Scheme –
The lower the expense ratio the better, but in some special cases where one wants to use STP (Systematic Transfer Plan) to invest in other scheme under same AMC one can look to pay higher expense ratio. The highest expense ratio is charged by Quant Liquid Fund & lowest by Union liquid fund.
What parameters should be overlooked in liquid schemes?
1. Investing based on past returns –
In liquid scheme, the current portfolio held decides the future returns & past returns don’t matter much.
2. Too low AUM in the scheme –
Lower AUM cause expense ratio to be on the higher side, just make sure that expense ratio isn’t too high which reduces your return below other instruments yielding higher returns, because
“Net returns = Yield to Maturity – Expense ratio”
3. Withdrawal before 7 days of investment –
If one withdraws before 7 days, the fund deducts exit load (penalty for early withdrawal) which reduces your payout.
These are small mistakes which need to be avoided, as these may compound with repetition or with large amounts. Make sure you do avoid these mistakes.
Conclusion –
Liquid funds as a category carry higher risks compared to overnight funds as they invest in more risky investments whereas overnight funds invests majorly in Sovereign instruments which keeps risks & yields low. These can be used to invest in other equity & debt schemes over a period of time or meet a defined goal/liability due in 3-6 months.
The Union Liquid Fund stands out with 0.07% expense ratio lowest in the category should be looked upon first if one wants to invest for short term. But of one is looking to STP’s one should look to invest in same AMC as it would provide the ease of transfer from one scheme to another provided the STP’s aren’t for longer periods.
In case you missed my previous article on Overnight fund, you can read it by clicking below.
In following articles we will focus on each of these debt sub categories –
A. Ultra Short Duration Fund –
B. Low Duration Fund –
C. Money Market Fund –
D. Short Duration Fund –
Holding any mutual funds which you want to be researched? Let me know in the comments section along with your valuable feedback by hitting the button below.
Notes -
Link to all available liquid funds.
Top 10 liquid funds by highest AUM -
3. Top 10 funds by lowest expense ratio -
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