When you invest, your sole intent is to see the growth of your principal amount without any loss of capital. Hence, you choose funds that could have lower risk with moderate returns, such as debt funds.
But the debacle of ILFS, followed by similar defaults in repayment by other top corporates, has led to a gargantuan credit crisis in debt mutual funds and an erosion of investors’ principal. Simply because many fund houses had taken exposure to debt papers issued by these defaulters.
From these instances, investors learned valuable lessons:
- What is considered to be safe, is not necessarily safe (Debt investments)
- One has to prudently choose a worthy fund from a well-established fund house that follows robust investments process and systems
Since then, investors have become extremely cautious, investing only in mutual fund schemes that are from reputed and established industry players. Investors perceive these large fund houses to be safer and highly adept at managing their investments; hence they have invested heavily in debt funds offered from these fund houses, in order to preserve their capital. Specifically, in liquid and overnight funds, for these funds invest in debt instruments having a short maturity period.
A liquid fund invests in debt & money market instruments with a maturity of up to 91 days only. They invest in money market instruments such as Certificate of Deposits (CDs), Commercial Papers, Term Deposits, Call Money, Treasury Bills, and government securities, among others.
And overnight funds, one of the lesser-known categories of debt mutual funds, offers high liquidity by investing in overnight securities having a maturity of 1 business day. They invest in short-term security instruments including Tri-Party Repos (TREPS), Reverse Repos, and debt instruments with overnight maturity.
However, though liquid fund entails low risk, they are not absolutely safe. The performance of the liquid funds depends on the quality of debt papers and money market instruments they hold in the portfolio.
Particularly, the proportion of Commercial Papers (an unsecured negotiable money market instrument issued by corporates, primary dealers and all India Financial Institutions as an alternative source of short-term borrowings).
Whereas for an overnight fund, there is a reinvestment risk, i.e. overnight funds may not be able to reinvest their proceeds at the same rate of return, and that doesn’t cause any capital erosion.
Among the two, investment risk involved for an overnight fund is least or almost zero and are more liquid.
Hence, the investors decided to play safe and invest mostly in these two funds for a short term of say up to a year. The AMFI monthly data that was released validate this, which observed that there was a steady rise in number of folios, especially in Liquid funds and overnight funds.
Table1: Rise in number of folios of various categories of Debt funds
|Open-ended Debt Schemes
|Ultra-Short Duration Fund
|Low Duration Fund
|Money Market Fund
|Short Duration Fund
|Medium Duration Fund
|Medium to Long Duration Fund
|Long Duration Fund
|Dynamic Bond Fund
|Corporate Bond Fund
|Credit Risk Fund
|Banking and PSU Fund
|Gilt Fund with 10 yr constant duration
Data as of July 31, 2019
Due to this, the average asset under management (AAUM) of liquid funds and overnight funds witnessed a surge of 8% and 40% respectively from April 2019 to July 2019.
Graph 1: Quarterly AAUM of top 10 industry players (Rs in Lakhs)
Data as of June 30, 2019
Except for Reliance Mutual Fund, UTI Mutual Fund, and ICICI Prudential Mutual Fund,remaining top industry players have witnessed a good steady growth on a quarterly basis and within a year it rose by double-digit.
Table 2: Year over year growth in AAUM of top ten industry players
|April – June 2018- Q1 AAUM (Rs in Lakhs)
|April – June 2019- Q1 AAUM (Rs in Lakhs)
|HDFC Mutual Fund
|ICICI Prudential Mutual Fund
|SBI Mutual Fund
|Aditya Birla Sun Life Mutual Fund
|Reliance Mutual Fund
|Kotak Mahindra Mutual Fund
|UTI Mutual Fund
|Franklin Templeton Mutual Fund
|Axis Mutual Fund
|IDFC Mutual Fund
Data as of June 30, 2019
This indicates that established players of the industry with robust investment systems in place have seen substantial growth in the form of an increase in investments due to the trust of investors, despite exposure to the credit crisis, debt markets facing liquidity crisis and slowdown in economy due to several macro and micro economic factors. What’s augmented inflows is the market regulatory body’s stringent actions to protect investors’ interest, which are as follows:
- Ban on upfront commission and new commission disclosure norms
- Uniform fact sheets
- Made mutual fund houses apply product labels with colour codes and risk-o-meter
- Revised the expense ratio, bringing down the cost of investing
- Introduction of Direct Plan for a mutual fund scheme
- Categorization and Rationalization of Mutual Fund Schemes
- Prudential norms governing liquid funds and other debt & money market instruments
- Graded exit load for liquid funds
- Changed valuation norms for below-investment grade securities
- Open market operations
- Asked mutual fund houses to shift all their investment to listed or to-be-listed equity and debt securities in a phased manner and reduce their exposure to unrated debt instruments from 25% to just 5%
- And even pulled up credit rating agencies for their high laxity and enhanced their disclosure norms
Due to this, investors were encouraged to invest in debt funds, as it would enable transparency when effective implementation is complete and may even help eliminate systemic risk.
Since then, several fund houses are seizing this opportunity by launching overnight funds and liquid funds extensively to gather more AAUM. These funds primarily invest in a judicious mix of debt and money market instruments having a short duration of less than a year.
Yes Mutual Fund (a new player) and PGIM India Mutual Fund have launched an overnight fund-YES Overnight Fund and PGIM India Overnight Fund.
The overnight fund is a category of debt scheme emerged after the SEBI’s recategorization norms. As per the asset allocation also, both, YES Overnight Fund and PGIM India Overnight Fund can invest up to 100% of the portfolio into Debt Securities and Money Market Instruments with maturity on or before the next business day.
On the risk-return spectrum, overnight funds are placed lower because these carry the least amount of investment risk due to its investment into instruments of shortest investment duration of one day.
So, the overnight fund is a plausible choice as it provides better returns than bank FDs, are more liquid, and, at least, that doesn’t cause any capital erosion.
But at the same time, the overnight funds generate returns, almost in line with general levels of interest rates and debt/money market conditions prevailing from time to time, i.e. in line with the repo rates and inter-bank lending rates in the overnight market, under normal conditions.
So, it is important, that one should be extremely careful while choosing a fund for investment. Investing in new funds makes less sense because it does not have a track record; especially when there are many funds available that have performed well within the category.
At the same time, one should select a worthy fund based on the evaluation of qualitative and quantitative parameters, that include the portfolio characteristics and quality of the debt instruments held by the scheme. These criteria accurately portray the fund’s performance across market cycles, risk involved and highlight the credibility of the fund house with processes and system in place.
Besides, don’t forget your own investment time horizon and appetite for risk. If you have a time horizon of less than a month and want to keep your money safe, it’s better to go with overnight funds. On the other hand, if you are willing to take a slightly higher credit risk for a better yield and can stay invested for at least three months, consider liquid fund.
[Read: The Best Liquid Funds For 2019]