Putting the Spotlight on Liquid Funds

Liquid funds are known to invest predominantly in highly liquid money market instruments and debt securities of quite short tenure. This is why they tend to provide high liquidity. 

Such funds invest in quite short-term instruments, which include Treasury Bills (T-Bills), Commercial Paper (CPs), Certificates of Deposit (CD), and Collateralised Lending and Borrowing Obligations (CBLO) having residual maturities of up to 91 days to generate optimal returns while ensuring safety and high liquidity. Generally, redemption requests in such liquid funds are processed in a span of one working (T+1) day.

Generally, the fund manager of a liquid fund aims to invest in liquid investments alone with good credit ratings in addition to a quite low possibility of a default. 

Typically, the returns take the back seat as capital protection remains more essential. Control over expenses in the form of good overall credit quality of the portfolio, low expense ratio and a disciplined approach to investing are a few of the crucial factors of a decent liquid fund.

Liquid funds and money market mutual funds are known to provide a more attractive option for retail investors. Surplus cash parked via investments in money market mutual funds tends to earn higher post-tax returns with a significant degree of safety of the principal invested and liquidity.

Investors prefer liquid funds to park their money for short periods, which could be generally from one day to three months. Wealth managers suggest liquid funds as an ideal investment tool when an investor has extra cash, which could be a large bonus, sale of real estate, and so on, and an investor is undecided about where to deploy that money. 

Similarly, those seeking investment opportunities in equities and long-term fixed-income instruments can also consider investing in liquid funds. A few equity investors tend to opt for liquid funds to stagger their investments into equity mutual funds using the Systematic Transfer Plan (STP). The thought is that this method may yield higher returns. 

However, the thumb rule is that in case the money is needed in a few days or weeks, liquid funds or money-market funds offer an ideal investment option. These are the only two categories where a retail investor’s money can be on demand with some modest return.

Similarly, in case the money is needed in a few weeks and goes up to a couple of years, such investors or medium-term investors must look at short-term debt funds or ultra-short-term debt funds, as they are known to provide a relatively superior return. 

While speaking of the trends in 2024, the primary driver behind the spike in debt inflows was the liquid fund category, showcasing a significant revival. The significant net inflows were witnessed in overnight, liquid and money market funds. 

At the same time, other categories with less than one year of maturities, such as ultra-short duration and low-duration funds, also highlighted net inflows. When it comes to choosing the right liquid fund, then a well-performing fund should beat its benchmark as well as its peer funds.

Similarly, investors must also verify that the fund has performed well consistently. This can be found out by checking its past returns. An investor can go for a direct fund with a low expense ratio. The returns between the two options are not likely to be quite different. However, the difference is forward returns versus past returns. Fixed deposits guarantee a forward return, while liquid funds can advertise their past returns alone and cannot confirm a fixed rate of future return.