We have looked at certain investment options for the mutual fund investor. Most of our discussion has been for investments that are to be made for long periods of time. Someone may ask what if we need to park the money for a very short time. Is there any option within the mutual funds? Well, the good news is; yes, there is a very good option called liquid funds. Let us understand what the liquid funds are, how they operate and how these can be beneficial to the investors.

Earlier, we saw two broader categories of mutual funds; equity mutual funds and fixed income mutual funds. While the former invest in the equity (stock) markets, the latter invest in debentures issued by companies and banks or bonds issued by the government. Thus, while the former take the risk of equity markets to generate superior returns over long periods of time, the latter stay away from the risk of equity markets. Liquid funds are one type of fixed income funds.

As mentioned in the previous paragraph, income funds (another name for fixed income funds) invest in debentures and bonds. These instruments have a definite maturity, i.e. the principal invested is returned after a certain period of time. The traditional fixed income funds invest in debentures with maturity period as long as 25 to 30 years, with average maturity (average of the maturity of all instruments) of around 3 years to 7 years. Liquid funds, on the other hand, invest in debentures with very short maturity. Earlier, these liquid funds used to invest in debentures with maturity less than 18 months to 2 years, with average maturity of less than 6 months. However, according to recent SEBI guidelines, liquid funds can invest in instruments with maturity not exceeding 90 days. Such guidelines only ensure that when the investor is looking at a liquid fund with a very short term view, the underlying investments also should be of short maturity.

What does the above mean to an investor? Well, an investor who needs to invest money for a period as short as 2 days can consider liquid funds. The liquid fund offers higher returns than interest paid on the savings account with instant liquidity and high safety of capital. Ever since liquid funds came into existence more than a decade back, there have been only two instances when the NAV (NAV of a mutual fund is the realisable market value of units) of some of the liquid funds were lower than the previous day. This shows us how low is the probability of losing money in liquid funds even for a single day. One must remember that the decade has been marked with certain periods of crisis never before witnessed by the present generation.

What are some of the applications of these liquid funds?
For starters, any money lying idle in a bank account for more than a week should be put in a liquid fund. I know of a friend, very money savvy, who used to purchase his monthly household items using his credit card, while simultaneously putting equivalent amount of money in a liquid fund to be withdrawn couple of days before the credit card bill payment date. This allowed him to earn even on the money he had spent. However, one must be very careful with such a strategy as missing the date with the credit card could be a lot costlier than what one can earn through the liquid funds.

Another application of liquid funds is ideal for businesses – be it small or large. In businesses, the cash flows are highly uncertain and hence periodically the business may end up with huge surplus. Such money can be invested in a liquid fund as it allows the flexibility to invest money for period as short as two days to as long as forever. When one is not certain when the money would be needed, liquid funds are the ideal choice.

Large companies with surplus cash also invest idle money in liquid funds, which is withdrawn when there is a need for capital investment, acquisition, business expansion, etc.

In the heydays of IPOs (Initial Public Offering) by companies raising money from the stock markets, many investors used to roll the money over from one IPO to another, either the money received as refund or the realisation on sale of shares on listing. The money lying idle between such opportunities was parked in liquid funds.

As mentioned earlier, liquid funds offer marginally higher return compared to savings bank account with high degree of safety.

Please remember that investment in liquid funds is all about convenience rather than returns. Your primary need is to get money when you need. Choose a mutual fund advisor who can help you with multiple transactions in liquid funds. Check with one before you start the relationship. You need not spread your money across many funds, one may be enough.

Wish you a very happy new financial year ahead!

To be continued
 

Amit Trivedi
 

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