When investors have surplus capital that they may need in the short term, they often look for an option that offers liquidity without taking on the volatility associated with equity investments. Liquid mutual funds are made for this, but it is important that investors know how they operate before deciding on them.
Three important aspects to consider are how redemption works, whether an exit load applies and how returns are generated. In this blog, we have explained these aspects of liquid funds, which can help investors make informed decisions before investing.
Understanding liquid funds
Liquid funds are open-ended debt mutual fund schemes that invest mostly in debt and money market securities maturing within 91 days. Investors looking to park surplus capital for relatively short periods find the short maturity of these securities quite appropriate. However, they are not risk-free investments.
When investors put capital into a liquid fund, the fund manager pools it with investments from other investors and invests the corpus in eligible short-term instruments. The units are given to investors as per the NAV applicable, and investors can redeem the units whenever they require. The returns are not fixed or guaranteed and will be dependent on the income and performance of the securities in which the fund invests.
Is instant redemption available in liquid funds?
Some of the liquid fund schemes allow instant redemption that lets the investors withdraw a fixed sum without undergoing the normal redemption process. This facility will, however, be subject to the terms and limits of the scheme, and investors should not presume that their entire investment is always available for immediate withdrawal.
Normal redemption takes place according to the applicable processing and settlement time. AMFI reports that normally, liquid and overnight funds offer redemption proceeds on the next business day, subject to the rules and cut-off time.
What is the exit load on liquid funds?
An exit load is a fee that might be deducted in case the investor redeems the mutual fund units within a certain period. SEBI has introduced a graded exit-load structure for redemptions of liquid funds made within seven days of investment. The applicable charge reduces as the holding period increases and becomes nil after the specified period.
It is always important to verify the exact terms in the scheme’s current documents before investing or redeeming. Mutual funds can alter the exit-load structures on a prospective basis within the regulatory framework.
How do liquid funds generate returns?
The returns from liquid funds are mainly associated with the income generated from the short-term debt and money market securities in the portfolio. These securities have short maturities, and thus liquid funds are generally less interest-rate sensitive than debt funds that invest in longer-maturity securities, but they are nonetheless subject to credit and market-related risks.
Returns are not guaranteed and can vary based on short-term interest rates, the securities held by the fund and their credit quality. Therefore, investors should not use historical returns as an indicator of future returns.
Who can consider liquid funds?
Investors who require their money to be easily accessible and would like to park surplus funds for a short term can consider liquid funds. They can be useful during periods where capital is not in use or is awaiting investment in other ventures.
But the suitability will depend on the liquidity requirement of the investor, his investment period and his risk appetite. Investors can use an investing app to research and manage mutual fund investments, but should review the scheme’s objective, portfolio, costs and risks before investing.
Final thoughts
Liquid funds are useful to investors as a way of keeping their spare money for a short period. However, it is important for investors to understand the features of the fund before they invest. Like, instant redemption is only available under the relevant scheme terms, exit charges may apply during the first holding period, and the returns are based on the performance of the market and not guaranteed.
Before investing, it is advisable to read the most recent Scheme Information Document and Key Information Memorandum relating to the specific fund. By becoming familiar with these documents, investors will be able to decide whether a liquid fund meets their short-term financial needs.
