The Complete Guide to Liquid Funds

The Complete Guide to Liquid Funds

Liquid Funds, as the name goes are a type of Mutual Fund that is for the investor who looks to make money by investing in Mutual Funds even for a day! Liquid funds are a very important avenue for the investor to park their money for a very short period, ranging from even a day to a week and more. Rather than letting money lie idle in a savings account, one can invest in liquid funds and earn returns.

Definition of Liquid funds

Liquid funds by industry regulation have to invest in fixed income instruments that have a residual maturity of fewer than 91 days. This implies that the portfolio from a technical standpoint consists of only money market instruments.

Portfolio Composition of Liquid Funds

The portfolio of liquid funds consists of Certificate of Deposits (CDs), Commercial Papers( CPs), Collateralized Borrowing and Lending Obligation (CBLO), Call Money and Cash. Most Mutual Funds companies ensure that a large part of the portfolio consists of CPs and CDs, with a smaller proportion assigned to CBLO and cash components. Since the returns or yield on CBLO, Call Money, and Cash is very low, to enhance the overall yield of the portfolio a higher proportion is assigned to CPs and CDs.

Typically, the higher yielding components are assigned 90 – 95% of the entire portfolio with the remainder being given to the other components.

Industry Size of Liquid Funds

As of March 2017, the total Mutual Funds industry size in India was 18.58 trillion rupees. Nearly one-fourth of the industry AUM. i.e. 22.5% consists of liquid funds assets. Today, most of these liquid fund assets in the MF industry are created by large corporate houses investing their idle cash. They have finance teams that take care of this and ensure that they are able to squeeze out returns from their surplus cash. However, recently, there has been greater participation by retail investors. Over the last one year, recent data has pointed out that there has been a growth of 80 – 100% of the retail assets of liquid funds.

Time horizon of Investment in Liquid Funds

With a maturity of fewer than 91 days in the papers that are in liquid funds, one can invest in these funds from a day to a month or slightly more. If the time horizon is more than a month than one should ideally look at ultra-short term funds since the yields could be higher.

Risk in Liquid Funds

Liquid Funds are not a risk-free investment. They are mutual funds and do carry certain risks. However, unlike an equity fund, the risks in liquid funds are pretty low. Giving a negative return for a liquid fund is possible in the rare scenario if there is a default in a security in the portfolio. In the case of a rating downgrade of a security, there could also be the possibility of a negative return. The likelihood of these scenarios are very rare and if one does some basics checks on investing, then these could be mitigated. To give an idea of risks in liquid funds, the risks are as follows:

  • Credit Risk: The risk of downgrade of a security
  • Default Risk: The risk of default in  security
  • Liquidity Risk: The risk of not getting your money back quickly
  • Fund Manager Risk: The risk of non-performance of the portfolio manager

The above are broadly the risks in liquid funds.

Exit Loads

Given that liquid funds are for investors with a time frame for a low as a day, there are no exit loads in liquid funds.

How to Select a Liquid Fund

Selecting a liquid fund is very important to ensure that your hard earned money yields you good returns and capital is preserved. When selecting a liquid fund one should look at the below:

  • Returns or part track record
  • AUM or size of scheme
  • Reputation of the Mutual Funds company
  • Performance ratings

To know more about how to select a liquid fund you may read: https://www.fincash.com/b/mutual-funds/liquid-mutual-funds-india

Liquid Funds Vs Savings Accounts

Liquid funds have been around for decades and have been used actively by large corporates to small sized companies to ensure that they keep on earning money on the surplus cash available with them. Money kept in the current account in most cases earns 0% interest, a liquid fund would give a yield of 6 – 8% p.a.(this is just an indication). Today, even retail investors, who earn 4% in a savings accounts, could potentially earn double returns by investing in liquid funds. With more awareness being spread about investing and Mutual Funds, it is only a matter of time where even retail participation in liquid funds takes off in a big way!

Disclaimer: The writer is the CEO – Fincash.com, the views expressed here are personal in nature and do not constitute investment advice or recommendation in any way. Please consult a specialist before making any investment decision. Mutual Fund investments are subject to market risks. Past performance in not an indicator of future performance

Written by Gaurav Perti

CEO - fincash.com.Gaurav has over 13 years experience across Financial Markets, Wealth Management, Insurance and Distribution. He has worked with Standard Chartered Bank(SCB) for over 10 years in roles such as Head-Business Banking and Head-Investments. He has done various roles in Wealth Management ranging from Product Management to Research to Sales & Distribution. Additionally, he has won the Best Structured Products House(India) for SCB in the years 2007, 2009, 2010 and 2011. He has also been a part of the team that won the "CNBC Best Financial Advisor Award" for SCB in the years 2012, 2013 & 2014. Gaurav has done a PGDM from IIM Lucknow and holds a Bachelors of Technology(B.Tech) from IIT Bombay.