Liquid Funds 101: What they are and how they work
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In an ever-evolving and dynamic capital market landscape, stability and flexibility have emerged to be just as important as returns for investors. Liquid funds offer one precisely that. These short-term investment instruments offer one a place to productively park and preserve their idle funds while also giving them seamless access to their capital, as and when they require, making them an integral part of investor portfolios the world over today.
In the following sections, we will explore what a liquid fund is, its advantages, and how to invest in one.
Liquid funds are a sub-category of debt mutual funds that invest in a diversified mix of fixed-income instruments such as government and corporate bonds, commercial papers, certificates of deposit, treasury bills, and other such money market instruments. These instruments however, have very short maturities – typically no longer than 91 days. Their main objective is to achieve capital preservation and a stable income, rather than capital appreciation.
Liquid funds have several advantages that align with an investor’s short, as well as long-term needs.
Seamless liquidity
Most liquid funds have no lock-in periods. This ensures quick access to one’s capital, anytime one needs it. Furthermore, redemption timelines on liquid funds are as low as 24 hours in most cases, making them ideal for parking funds for unforeseen contingencies.
Lower risk levels
Liquid funds invest in high-quality debt instruments, often rated A1 or A2 by credit rating agencies such as ICRA (Investment Information and Credit Rating Agency) or CRISIL (Credit Rating Information Services of India Limited). A lack of susceptibility to credit rating changes ensures their portfolio remains protected against major against net asset value (NAV) fluctuations, whereas a short investment horizon also ensures reduced susceptibility to interest rate fluctuations, making them a suited to conservative investors.
Expense ratios and exit loads
As per the rules of the Securities and Exchange Board of India (SEBI), expense ratios on liquid funds are capped at 1.05% of their daily NAV. This ensures that returns aren’t significantly diminished when one chooses to redeem their investments. Additionally, exit loads on liquid funds are also capped at just 0.0070% by SEBI, further enhancing capital preservation.
Potentially higher returns than savings accounts
Liquid funds’ performance is market linked. With changes in interest rates, their NAVs see an increase as well. This allows them to potentially provide one with higher returns as compared to savings accounts or fixed deposits. Bear in mind however, they are also susceptible to negative credit rating and interest rate fluctuations, which may impact returns.
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