Liquid funds can be considered as baby steps to enter the world of mutual funds. As the name suggests, liquid funds mean funds in which the amount invested can also be redeemed with ease. Here the funds are invested in securities which typically have a lower maturity and the risks of capital erosion is minimal. How is this possible? Before we undertake the process of investing in liquid funds, let us have a glimpse of the mutual fund scenario in India. As per AMFI data as of March 2018, the assets under management (AUM) is in over Rs 21.36 lakh crore. And liquid and money market schemes constitute Rs 3.36 lakh crore, close to 16% of the overall AUM.
What is the share of retail investors (investors who invest less than Rs 5 lakh in the mutual fund scheme) in the liquid fund? It is less than 3%. Investments in the liquid funds have consistently generated a return in excess of 6% per annum across all time horizons and at times also in excess of 9%, for certain quarters. Over a 5-year period, the average returns has been in excess of 8% .
Do remember that the savings bank (SBI) interest rate is 3.5% per annum and bank deposit rate for less than one year is 6.4%. So, now you have more reasons to take the plunge and invest in this asset class, which is easy to use, understand and execute.
One should not confuse liquid funds with debt funds. Liquid fund is a part of the universe of debt funds. Liquid funds do not take credit calls or interest rate calls, which debt funds do. So, you should not invest knowingly or unknowingly if your liquidity needs are between 0-180 days or even up to 365 days.
Liquid funds invest in instruments like certificate of deposits, treasury bills, commercial paper, and term deposits of varying maturities up to 91 days. This allows easy withdrawal and redemption of funds for the fund manager.
One should not invest in a liquid fund based on past performance. In the year gone by, we had a case wherein a particular scheme of a mutual fund AMC invested in longer duration instruments of a corporate bond, which defaulted on maturity. Higher interest rate should not be the consideration.
Look at the credit rating of the instruments invested in. Higher the credit rating as in AAA +, AAA, lower the risk of default. Another factor is cost of funds or Total Expense Ratio (TER) which needs to be considered—lower the cost, better it is. Again as an investor, be it first time or not, invest in schemes of a fund house with a track record of managing liquid fund schemes over a longer time frame and with a consistent performance.
And not to forget, the composition of the portfolio, as noted earlier, should not be ignored. Simpler the portfolio composition, the choice becomes easier for you as an investor. With these four pillars as a checklist, you as an investor, should not hesitate to invest in liquid funds and get an additional return on the funds parked in the savings bank. Just do not get too greedy and dilute your investment discipline. If you are looking for alpha and beta returns, then it is called wealth creation and not temporary parking of funds, which is what liquid funds are all about.
The writer is founder and managing partner, BellWether Advisors LLP