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How to Invest in Liquid Funds?

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StockXcel

| Oct 20, 2023

How to Invest in Liquid Funds?

Synopsis

Liquid funds are a type of mutual fund that invests in short-term debt securities, such as treasury bills, commercial paper, and certificates of deposit. They are considered to be a low-risk investment and are a good option for investors who need access to their money quickly. Liquid funds typically offer higher yields than bank fixed deposits, but they are not as liquid as stocks or bonds. This means that it may take some time to sell your investment if you need to access your money. Overall, liquid funds are a good option for investors who are looking for a safe and liquid investment with the potential for higher yields than bank fixed deposits.

Introduction

Liquid funds are a type of mutual fund that invests in short-term debt securities, such as treasury bills, commercial paper, and certificates of deposit. They are designed to provide liquidity and safety to investors, and they typically offer higher yields than bank fixed deposits.

Landscape of Liquid Funds in India

The landscape of liquid funds in India provides investors with a safe and convenient avenue for parking surplus funds while aiming for a modest return. Liquid funds are a type of mutual fund that primarily invests in short-term money market instruments such as treasury bills, commercial papers, certificates of deposit, and other highly liquid, low-risk debt securities.

Key features of the liquid fund landscape in India include:

  • Low Risk and High Liquidity: Liquid funds are known for their low-risk profile, making them an attractive option for investors seeking capital preservation. The underlying securities are typically of short duration and high credit quality, reducing the risk of default. Additionally, investors can easily redeem their investments with minimal or no exit load, providing high liquidity.
  • Stable Returns: Liquid funds aim to provide stable returns that are relatively higher than traditional savings accounts or fixed deposits. The returns are generally linked to prevailing money market interest rates, making them an appealing choice for investors looking for short-term investment options with better potential returns.
  • Investment Horizon: Liquid funds are suitable for investors with a short investment horizon, ranging from a few days to a few months. They are commonly used by individuals and corporations to temporarily park funds before deploying them in other investment avenues.
  • Tax Efficiency: Liquid funds offer tax advantages over traditional fixed deposits. Gains from investments held for more than three years are considered long-term capital gains and are subject to a lower tax rate, whereas gains from fixed deposits are taxed at the individual's income tax slab rate.
  • Easy Access: Investors can purchase and redeem liquid fund units through various channels, including online platforms, mobile apps, and asset management companies. The ease of access and quick redemption process add to the appeal of liquid funds.
  • NAV Calculation: The Net Asset Value (NAV) of liquid funds is calculated daily. This allows investors to monitor the value of their investments accurately and make informed decisions.
  • Expense Ratio: Liquid funds typically have a low expense ratio due to their simple investment strategy and low portfolio turnover.
  • Institutional and Retail Participation: Both institutional and retail investors participate in the liquid fund market. Corporate treasuries, individuals, and businesses utilize liquid funds to manage short-term cash flows efficiently.
  • Regulations and Safety: Liquid funds are regulated by the Securities and Exchange Board of India (SEBI) and follow stringent investment guidelines and risk management practices to ensure investor protection.

It's important to note that while liquid funds provide higher returns compared to traditional savings accounts and fixed deposits, they also come with some level of risk, albeit relatively low. The value of investments in liquid funds can fluctuate due to changes in interest rates and market conditions.

Before investing in any financial product, including liquid funds, investors should carefully review the fund's investment strategy, portfolio holdings, expense ratio, historical performance, and risk factors. Consulting with a financial advisor can help investors make informed decisions aligned with their financial goals and risk tolerance.

How to Invest in Liquid Funds

There are two main ways to invest in liquid funds:

  • Mutual funds: Liquid funds are available as mutual funds. You can invest in liquid funds through a broker or directly with the fund house.
  • ETFs: Liquid funds are also available as ETFs. ETFs are traded on the stock exchange, so you can buy and sell them just like stocks.
  • Here are a few examples of liquid funds that are traded actively.
    ETF Name Ticker
    IDFC Liquid ETF IDFCLIQUIDETF
    SBI Liquid ETF SBINFL
    Axis Liquid ETF AXISLIQUIDETF
    Motilal Oswal Liquid ETF MOETLIQ

Recent Liquid Funds That Failed

Let’s also look at some of the recent failures. There have been a few liquid funds that have failed in recent years. The key factor to look at here is to see what kind of concentrated bets they are making and the quality of the companies they invest in. Here are a few examples of funds that failed:

  • Fund Name - Franklin India Income Opportunities Fund
  • Fund House - Franklin Templeton Investments
  • Year of Failure - 2020
  • Fund Name - DHFL Liquid Fund
  • Fund House - DHFL Pramerica Mutual Fund
  • Year of Failure - 2020
  • Fund Name - Indiabulls Liquid Fund
  • Fund House - Indiabulls Asset Management Company
  • Year of Failure - 2021
Next let’s look at the underlying companies that failed.
Name
Description
IL&FS
Infrastructure conglomerate that defaulted on its debt in 2018.
DHFL
Housing finance company that defaulted on its debt in 2020.
AAIL
Infrastructure conglomerate that defaulted on its debt in 2021.

These are just a few examples of liquid funds that have failed in India in recent years. There are many other factors that can contribute to the failure of a liquid fund, such as poor management, market conditions, and fraud. Investors should always do their research before investing in any liquid fund. At the end of the day, the quality of the underlying investments is what matters.

Investment Tips for Liquid Funds

Here are some tips for investing in liquid funds:

  • Invest with a reputable fund house: Choose a fund house that has a good track record of managing liquid funds.
  • Read the fund's prospectus carefully: Make sure you understand the risks involved before investing.
  • Monitor the fund's performance: Keep an eye on the fund's performance and make sure it is meeting your expectations.
  • Avoid investing in liquid funds that invest in illiquid assets: Liquid funds are supposed to invest in liquid assets, such as money market instruments. However, if a fund invests in illiquid assets, such as corporate bonds, it may have difficulty selling these assets quickly if there is a redemptions.
  • Avoid investing in liquid funds that are poorly managed: If a fund is poorly managed, it may make investment decisions that lead to losses.

By following these tips, you can help reduce the risk of investing in a liquid fund that fails.

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