Tags: Wealth Management, Investment Lesson, Mutual Funds, Stock market, Budget, Finance, Investing, Personal Finance, Investment
Article Summary
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It is common for prospective mutual fund investors to ask: “Is mutual fund safe?” Popular discussions around mutual funds may revolve around wealth creation through equity and equity-oriented mutual funds that invest predominantly in equities. Turbulence in equity markets can be a source of concern to both new and existing mutual fund investors.
At the same time, it is important to point out that there are debt and debt-oriented mutual funds that invest predominantly in debt securities. They are relatively lower risk investments and experience far less turbulence than equity funds. Such funds can play multiple roles, such as meeting emergency expenses and short-term needs, preserving capital, containing the overall risk of investments, diversifying portfolios, and providing regular income.
Against this backdrop, those looking for less-risk mutual funds may consider overnight funds. This will make many ask the obvious next question: “What is an overnight fund?”
What is an overnight mutual fund? They are very low risk debt funds that invest in short term debt securities such as reverse repos, tri-party repos (TREPs), besides other debt and money market securities with a residual maturity of one business day. On maturity on the next day, they reinvest the funds in the scheme including the coupon or interest payment in debt securities with one day maturity, with the investment-reinvestment cycle being perpetuated. These funds may invest up to 5% of the net assets in GSECs/T-Bills having up to 30 days residual maturity for the purpose of placing the same as margin and collateral for certain transactions. These funds offer suitable investment opportunities for an investment horizon of up to 1 month.
Very low risk mutual fund With investments largely in debt securities of one day maturity, overnight funds do not face debt funds’ major risks of interest rate fluctuations and credit risk. Thus, among debt mutual funds, they face relatively the lowest possible chances of experiencing volatility, making them relatively safer investment avenues.
Liquidity Overnight funds do not have entry or exit restrictions i.e., entry and exit loads, and as such investors can exit their investments easily when required without paying any penalty, offering the investors liquidity on their monies.
Risk-Return Trade-off And “Safety” Of Investments
Any discussion on “What is an overnight fund?” or “What are overnight mutual funds?” needs to cover the risk-return trade-off to better understand this type of mutual fund.
Risk and return trade-off It is important to point out two critical aspects related to any discussion on “safety” in investments. First, any investment in any asset class or investment category will have distinct risks associated with it. The nature of risks varies across investment categories.
In the case of equity investments, including equity and equity-oriented funds, market volatility, international and domestic political and economic developments and events impacting companies and information disclosure by them are risks that impact them.
For debt investments, including those in debt funds and debt-oriented hybrid funds, the risks emanate from interest rate movements, repayment, or credit risk, besides the risk of reinvestments and inflation. In other words, you can have high-risk debt investments, such as those that invest in longer-term debt securities and get more impacted by interest rate movements and inflation. There are also those debt funds that invest in higher credit risk debt investments with a potential for higher returns. The question then is, where do overnight funds figure in this picture?
Historical Returns of Overnight Mutual Funds
By investing in very low risk, liquid and very short term debt investments of one day maturity, overnight funds typically offer low returns amongst the various types of available debt mutual fund offerings. Despite this fact, overnight funds can offer better returns and liquidity over traditional investment options. It is worth pointing out that the primary objective of investments in overnight funds is to get the high security and liquidity of the investments, and not returns.
How Overnight Funds Help Investors
Provide low risk, high liquidity parking slot Overnight funds can serve as a low risk and highly liquid parking slot for keeping money ready for imminent needs. For example, impending down payment for a home and upfront payment during children’s admission to a higher education institution. Money can be transferred from equity or other debt funds to overnight funds for this purpose. These funds can also be used by small business owners for parking money to meet their short-term needs like making utility payments and paying employee salaries and vendors besides regulatory fees and charges.
Helps better use of cash surplus Often, on the receipt of a large lump sum such as real estate sales proceeds, severance package, commissions or bonus, a person needs time to plan its use. By parking the large sum in an overnight fund, the investor can typically benefit from preventing such funds from remaining idle in cash while allowing such funds to grow in overnight funds.
Facilitates capital preservation Overnight funds may help keep your capital preserved during crises in financial markets. During such volatile times, the investors can park their capital gains from other investments in overnight funds while they decide the future course of deployment of their funds.
Aids in portfolio rebalancing In the aftermath of market booms and crashes, you may need to rebalance the mix of investments in line with your needs and risk appetite. Overnight funds can serve as a medium of funds transfer across investments for portfolio rebalancing.
Choosing A Suitable Overnight Fund
Like other mutual funds, investors would like to choose a suitable overnight fund. Since investments in the overnight funds are generally for a shorter term and these funds invest predominantly in 1-day maturity debt and money market securities, there is not much of a difference in these funds. Investors can look at the funds’ size and expense ratios while making their investment decisions.
Funds’ expenses, as expressed by the expense ratio, can be a key differentiator since the difference in returns may not be large. While overnight funds typically have low expense ratios, consistently performing funds with low expense ratios should help significantly narrow down the choice.
Clearly, the role of mutual funds in wealth preservation is as important as wealth creation, a function for which it is more popular. In this context, overnight funds can play an important role along with other debt funds.
FAQs
1. Who may invest in overnight funds?People who need to keep money ready in a low risk and liquid investments for an impending goal may consider overnight funds. The same applies to parking capital gains from growth investments during turbulent capital markets. They can also function as a temporary parking slot for lump sums on their receipt before a plan is made for their use. Overnight funds can serve as a medium to transfer funds during portfolio rebalancing.
2. Are there downsides to overnight funds?These funds typically provide low returns, and considering the nature of their investments, they are not suitable for long-term investments.
Disclaimer:
The information set out above is included for general information purposes only and is not exhaustive and does not constitute legal or tax advice. All complaints regarding Mutual Fund can be directed towards visit www.scores.gov.in (SEBI SCORES portal). Readers are requested to make informed investment decisions and consult Chaitanya Financial Consultants – 9000628943 / mfd.mmr@gmail.com to determine the financial implications with respect to investing in Mutual Funds.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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