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Know your debt investments: How to make the most of liquid funds

Till date, when you take money out of liquid funds, you get the money in a day. Soon, liquid funds will give you money in a matter of minutes, with the help of technology.

business Updated: May 17, 2017 07:46 IST
Kayezad E. Adajania
Kayezad E. Adajania
Live Mint, Mumbai
Debt investment,Mutual fund,Liquid funds
Risk in a liquid fund is minimal, though not completely absent, but the returns are quite high.(Getty Images/iStockphoto)

Instead of parking your cash in a savings bank account, why not put it where it fetches higher returns? A liquid fund is one such option. The risk is minimal, though not completely absent. Here’s how to make the most of a liquid fund.

What is it?

A liquid fund is a debt mutual fund scheme. You use it if you have excess cash and think you might need the money in a few days or weeks or months. If you wish to invest a large sum in an equity fund, but want to stagger the investments over a period, put your money in a liquid fund and enrol for a systematic transfer plan (STP) whereby you invest a fixed sum from your liquid fund in an equity fund each month.

Returns and risks

Your liquid fund, like every other mutual fund scheme, invests in securities that have a market price. When market prices of these securities move up or down, so does your mutual fund’s net asset value (NAV). But a liquid fund’s NAV doesn’t move up or down as much as other funds.Here’s why. As per rules laid down by the capital market regulator, Securities and Exchange Board of India (Sebi), if a security matures in under 60 days, it need not be marked to market.

Just the interest component needs to be added. In simple words, whatever interest your debt fund earns through the tenure of a security, it will divide the total interest component equally for the number of days for which it holds the security. The security’s price remains steady. Hence, your liquid fund’s NAV movement is linear.

Does this mean your liquid funds are risk-free? No. Your liquid fund can invest in scrips with maturity of up to 91 days. Therefore, if it invests in scrips that mature between 60 and 91 days, it needs to mark them to market, depending on their credit rating. To keep things simple, if such an underlying company defaults on its interest and/or principal repayment, the scrip’s credit rating drops and so does its market price. If your liquid fund has invested in such a security, its NAV falls too.

Recently, the net asset values of four of Taurus Asset Management Co. Ltd’s debt schemes (one of which was a liquid fund) went down sharply because one of the companies in which all these schemes had invested in defaulted on repayment. Typically, most debt funds invest in scrips that mature in around 15 to 20 days to curtail their risk. You can reasonably expect your liquid funds to give around 6-7% returns in a year.

What is so special about liquid funds?

Till date, when you take money out of liquid funds, you get the money in a day. Soon, liquid funds will give you money in a matter of minutes, with the help of technology. Some ultra short-term funds have been offering you this facility, but Sebi recently said that only liquid funds can offer this facility, and not ultra short-term funds. Sebi has capped this limit at ₹50,000 a day or 90% of your folio’s value, whichever is lower.

First Published: May 17, 2017 07:46 IST