What are Liquid Funds?

Liquid funds are open-ended debt mutual funds that primarily invest in short-term money market instruments with a maturity of up to 91 days.

Liquid mutual funds invest in money market instruments such as Certificate of Deposits (CDs), Commercial Papers (CPs), Term Deposits, Call Money, Treasury Bills, and so on.

The investment objective of a Liquid Fund is capital preservation and ensuring liquidity through judicious investments in the money market and debt instruments. It benchmarks its performance against the Crisil Liquid Debt Index and/or Crisil 1-year T-bill Index.

Graph: Liquid Fund Position on the Risk-Return Spectrum

(For illustration purposes only) 

Given the type of securities Liquid Funds hold, usually they entail low risk. The interest rate and credit risk are relatively low compared to the other sub-categories of debt funds.

Liquid funds help prioritise safety and liquidity by investing in shorter-maturity debt & money market instruments.

Thus, on the risk-return spectrum of debt mutual funds, Liquid Funds are placed at the lower end.

Having said that, you ought to be careful when choosing Liquid Funds to invest in. Interest rate risk, liquidity risk, default risk, etc., that apply to debt investments impact a Liquid Fund. It’s important to learn from the debt fund crisis of the past -the IL&FS episode, the DHFL crisis, and so on.

[Read: Is Your Liquid Fund Really Safe and Liquid?]

Don’t live by the following myths while investing in Liquid Funds…

Myth #1: Liquid Funds are risk-free — No, the fact is there is some element of risk when you invest in Liquid Funds. They are not completely risk-free or safe as opposed to parking money in a savings bank account or short-term deposit with a robust bank.

If a Liquid Fund invests in debt papers of private issuers and compromises on quality to generate slightly better returns, the risk could be elevated.

[Read: Does Your Liquid Fund Follow the Principle of Safety? Know Here…]

Myth #2: NAV of a Liquid Fund only goes up (does not fluctuate) — No, this isn’t true. The NAV is mark-to-market, so can fluctuate for multiple reasons.

That being said, compared to some other sub-categories of debt funds and more volatile equity funds, the fluctuation in the NAV is far less. Only if the portfolio characteristics are compromised, the NAV of a Liquid Fund could fall more. This is why it is important to understand the portfolio characteristics of a Liquid Fund. Don’t simply zero in on any Liquid Fund out there.

Myth #3: Liquid Funds are for conservative investors only — Again, not true! Liquid Funds serve different objectives. When you turn conservative as equities seem expensive, deploying money to a Liquid Fund is sensible, but when equities look attractively priced and it’s time to go aggressive, you could switch your money from a Liquid Fund. This way it helps both, conservative and aggressive investors enabling them to follow a flexible approach.

How to Select the Best Liquid Funds for 2024?

Well, here’s what you need to do:

• Evaluate the investment ideologies of the fund houses
• Shortlist schemes from fund houses that follow robust investment processes and systems
• Assess the fund manager’s experience
• Study the Scheme Information Document (SID) carefully
• Ensure the expense ratio is on the lower side (whereby you earn slightly better returns than a savings bank account)
• Check the portfolio of the Liquid Fund carefully (for the type of debt & money market instruments held, their credit ratings, the average maturity, Yield-To-Maturity (YTM), and the Modified Duration (MD) of the portfolio)

Also, watch out for negative observations by independent credit rating agencies.

A Liquid Fund should prioritise safety and liquidity, and not engage in yield hunting to generate higher returns. Note, that’s not the primary investment objective of a Liquid Fund.

The fund manager should also make adequate provisions to deal with unforeseen liquidity crunch and redemption pressure.

Following the principle of safety when it comes to holding cash-and-cash equivalents, you would be better off with Liquid Funds that invest predominantly in Government securities (G-Secs), AAA/A1+ rated Public Sector Undertakings (PSU) debt, and T-bills, where there is no private corporate credit risk, the portfolio is highly liquid, it is marked-to-market daily (whereby the declared NAV is real), the AUM trend is stable, and the portfolio is disclosed regularly.

Furthermore, after you have made the best choice preferably choose the Direct Plan. Under the Direct Plan, a lower expense ratio is charged than a regular plan, which may earn you a tad extra return.

What Kind of Returns You Can Expect from Liquid Funds?

In the last one year in a rising interest rate scenario (where the RBI has focused on withdrawing its accommodative stance), Liquid Funds as a sub-category of debt funds have delivered around 6.98% absolute returns (as of November 20, 2023)–higher than a conventional savings bank account.

Table 1: Category Average Returns of Liquid Mutual Funds and Benchmark Indices

Liquid Funds	Abs Returns (%)				CAGR (%)
	1 Month	3 Months	6 Months	1 Year	2 Years	3 Years
Category Average Returns	0.59	1.73	3.46	6.98	5.74	4.91
CRISIL Liquid Debt Index	0.60	1.76	3.52	7.07	5.89	5.11
Crisil 1 Yr T-Bill Index	0.66	1.79	3.40	6.97	5.29	4.70

Direct Plan and Growth Options considered. Category average for a total of 36 Liquid Funds.
Returns are Point to Point and in %. Past performance is not an indicator of future returns.
*Please note, this table only represents the best-performing schemes based solely on past returns and is NOT recommendations as such. Speak to your investment advisor for further assistance before investing.
Mutual Fund investments are subject to market risks. Read all scheme-related documents carefully.
Data of November 20, 2023
(Source: ACE MF, PersonalFN Research) 

Which are the Best Liquid Mutual Funds for 2024?

A plethora of Liquid Funds exist, but considering the portfolio characteristics, i.e. the quality and the nature of the underlying securities held, the top 3 Liquid Funds that shall keep your money safe and liquid (amidst the macroeconomic and geopolitical uncertainty) in 2024 are:

1) Union Liquid Fund

2) Quantum Liquid Fund

3) Parag Parikh Liquid Fund

These schemes follow the principle of safety over returns and are among the best and top Liquid Funds available out there.

Table 2: 3 Best Liquid Mutual Funds for 2024

Scheme Name	Absolute (%)				CAGR (%)		Risk Ratios
	1 Month	3 Months	6 Months	1 Year	2 Years	3 Years	SD Annualised	Sharpe
Union Liquid Fund	0.60	1.75	3.50	7.10	5.82	4.98	0.09	2.86
Quantum Liquid Fund	0.58	1.70	3.39	6.81	5.57	4.75	0.07	2.94
Parag Parikh Liquid Fund	0.57	1.67	3.36	6.63	5.46	4.68	0.07	2.87
Category Average	0.59	1.73	3.46	6.98	5.74	4.91	0.09	2.71
Crisil 1 Yr T-Bill Index	0.66	1.79	3.40	6.97	5.29	4.70	0.39	0.63
Crisil Liquid Debt Index	0.60	1.76	3.52	7.07	5.89	5.11	0.06	3.96

Performance as of November 20, 2023. Returns are Point to Point and in %, calculated using the Direct Plan-Growth optionThe risk-free rate is considered as 5% p.a.
Past performance is not an indicator of future returns.
*Please note, this table only represents the best-performing schemes based solely on past returns and is NOT recommendations as such. Speak to your investment advisor for further assistance before investing.
Disclaimer: Quantum Liquid Fund is a scheme from Quantum Mutual Fund, a group company of Quantum Information Services Pvt. Ltd.
PersonalFN is not in receipt of any commission directly or indirectly for suggesting the scheme.
Mutual Fund investments are subject to market risks. Read all scheme-related documents carefully. 

Here are some details of why these schemes are the best in the Liquid Mutual Funds category…

1) Best Liquid Fund for 2023 #1: Union Liquid Fund

Launched in June 2011, Union Liquid Fund (ULF) aims to provide reasonable returns commensurate with lower risk and a high level of liquidity through a portfolio of money market and debt securities.

Table 3: Top-10 holdings of Union Liquid Fund

Security Name	Asset Type	Rating	Holding (%)
91 Days Treasury Bill – 07-Dec-2023	Treasury Bills	SOV	2.60
Punjab National Bank (06-Dec-23)	Certificate of Deposit	AAA & Equiv	2.60
LIC Housing Finance Ltd. -355D (12-Dec-23)	Commercial Paper	AAA & Equiv	2.60
91 Days Treasury Bill – 21-Dec-2023	Treasury Bills	SOV	2.60
Kotak Mahindra Prime Ltd. -364D (23-Jan-24)	Commercial Paper	AAA & Equiv	2.58
91 Days Treasury Bill – 02-Nov-2023	Treasury Bills	SOV	1.82
ICICI Home Finance Company Limited -77D (07-Nov-23)	Commercial Paper	AAA & Equiv	1.75
Canara Bank (09-Nov-23)	Certificate of Deposit	AAA & Equiv	1.74
Reliance Industries Ltd. -91D (10-Nov-23)	Commercial Paper	AAA & Equiv	1.74
Bank of Baroda (15-Nov-23)	Certificate of Deposit	AAA & Equiv	1.74

Data as of October 31, 2023
(Source: ACE MF, PersonalFN Research) 

Union Liquid Fund holds a well-diversified portfolio of around 70 debt securities across issuers with a maturity profile of largely up to 3 months.

ULF has held its assets mainly in Certificate of Deposits (CDs), Commercial Papers, Treasury Bills (T-bills), and cash-and-cash equivalents in line with its investment mandate.

By and large, ULF has consistently invested in highly-rated instruments. As per its portfolio as of October 2023, ULF holds 72.1% of its assets in AAA and equivalents, sovereigns (essentially T-bills). CP and CDs comprise, 38.7% and 33.5% respectively, T-bills 17.4%, 0.1% in an unrated Alternative Investment Fund (AIF), specifically the Corporate Debt Market Development Fund (added recently), and the rest in cash-and-cash equivalents as per latest portfolio (as of October 2023).

The weighted average portfolio of Union Liquid Fund is 0.08% as of October 31, 2023, one of the lowest in the industry.

ULF is managed by Mr Parijat Agarwal, Head – Fixed Income of Union Asset Management Company, and Mr Devesh Thacker.

Parijat has over 27 years of experience. He has worked with SBI Mutual Fund as Head – Fixed Income, State Bank of Mauritius Limited, where he handled the responsibility of managing the entire Treasury function of the bank and SUN F&C Asset Management as Fund Manager managing Fixed Income and Hybrid Funds. Parijat holds a B.E. (Electronics & Communications), PGDM from IIM Bangalore.

Devesh professional career spans over 22 years. Before joining Union Mutual Fund in 2011 he worked with Sahara Asset Management Company. He holds a Bachelor of Commerce (Honours) degree and is a Postgraduate from the University of Pune.

As seen in Table 2, ULF has fared better than the category average across time periods and clocked competitive returns in line with the benchmark index, i.e., the Crisil Liquid Debt Index. ULF is well-suited for investors, who do not mind higher exposure to CDs, CPs and T-bills – aiming to sort of balance risk and returns.

2) Best Liquid Fund for 2024 #2: Quantum Liquid Fund

Launched in April 2006, Quantum Liquid Fund (QLF) aims to provide optimal returns with a low level of risk while keeping liquidity high through judicious investments in the money market and debt instruments.

Table 4: Top-10 holdings of Quantum Liquid Fund

Security Name	Asset Type	Rating	Holding (%)
182 Days Treasury Bill – 07-Dec-2023	Treasury Bills	SOV	16.85
Bank of Baroda (15-Nov-23)	Certificate of Deposit	AAA & Equiv	8.46
Small Industries Development Bank of India -91D (22-Nov-23)	Commercial Paper	AAA & Equiv	8.45
Export Import Bank of India -91D (07-Dec-23)	Commercial Paper	AAA & Equiv	8.42
NABARD -90D (13-Dec-23)	Commercial Paper	AAA & Equiv	8.41
Canara Bank (14-Dec-23)	Certificate of Deposit	AAA & Equiv	8.41
364 Days Treasury Bill – 11-Jan-2024	Treasury Bills	SOV	8.37
91 Days Treasury Bill – 30-Nov-2023	Treasury Bills	SOV	6.75
91 Days Treasury Bill – 25-Jan-2024	Treasury Bills	SOV	6.68
07.68% GOI – 15-Dec-2023	Government Securities	SOV	5.09

Data as of October 31, 2023
(Source: ACE MF, PersonalFN Research) 

QLF prioritises safety and liquidity over returns and invests predominantly in Government Securities, T-bills and Money Market instruments issued by Public Sector Undertakings.

This distinguishes QLF from its peers, which often aim for higher returns by maintaining substantial exposure to instruments issued by private entities, potentially exposing investors to elevated credit risks.

Historically, QLF has adopted an ultra-cautious approach for its portfolio and has never chased yields for additional returns, thereby making it truly a low-risk Liquid Fund. Quantum Mutual Fund, as a fund house, follows robust investment processes and systems.

As of October 2023, the fund held a compact portfolio comprising 16 debt securities and cash and cash-equivalent assets. Top-10 holdings accounted for 85.9% of the fund’s portfolio.

The weightage of ‘AAA and equivalents’ are to the tune of 45.5% in the fund’s portfolio. Besides it has 48.8% exposure to sovereign debt, which reflects its penchant for high-credit quality. CDs, CPs, and corporate debt accounted for 16.9%, 25.3%, and 3.4%, respectively, while the fund held around 0.4% in cash-and-cash equivalent assets. In the past month, the fund allocated a minor 0.2% to an unrated Alternative Investment Fund, specifically the Corporate Debt Market Development Fund.

As of October 31, 2023, Quantum Liquid Fund’s weighted average expense ratio is 0.15%, which is lower than some of its category peers.

QLF is managed by Mr Pankaj Pathak. He has over 14 years of experience in fixed-income investments and research and holds a Post Graduate Diploma in Banking and Finance from the National Institute of Bank Management, Pune and is a qualified CFA (Chartered Financial Analyst).

QLF is ideal if you are looking for an alternative to parking money in a savings bank account, and modest return/income from it over the short-term — over a few months, say 3 to 6 months or a year.

Over 3 months, 6 months, and 1-year returns, as seen in Table 2, QLF has generated competitive returns. QLF exhibits significantly lower volatility in performance compared to its high-performing counterparts. Hence, QLF is well-suited for conservative investors.

3) Best Liquid Fund for 2024 #3: Parag Parikh Liquid Fund

Launched in May 2018, Parag Parikh Liquid Fund’s (PPLF) primary investment objective is to provide optimal returns with lower risk and higher liquidity through judicious investments in money market and debt instruments.

PPLF by consistently holding a quality portfolio since its inception has prioritised the safety of the invested principal and focused on liquidity. It avoids unnecessary credit risk that could jeopardise the safety and liquidity of the portfolio.

Table 5: Top-10 holdings of Parag Parikh Liquid Fund

Security Name	Asset Type	Rating	Holding (%)
91 Days Treasury Bill – 09-Nov-2023	Treasury Bills	SOV	7.39
182 Days Treasury Bill – 23-Nov-2023	Treasury Bills	SOV	7.37
91 Days Treasury Bill – 29-Dec-2023	Treasury Bills	SOV	7.32
91 Days Treasury Bill – 02-Nov-2023	Treasury Bills	SOV	6.17
182 Days Treasury Bill – 07-Dec-2023	Treasury Bills	SOV	6.12
91 Days Treasury Bill – 14-Dec-2023	Treasury Bills	SOV	6.12
182 Days Treasury Bill – 21-Dec-2023	Treasury Bills	SOV	6.11
91 Days Treasury Bill – 30-Nov-2023	Treasury Bills	SOV	4.91
182 Days Treasury Bill – 04-Jan-2024	Treasury Bills	SOV	4.87
91 Days Treasury Bill – 11-Jan-2024	Treasury Bills	SOV	4.87

Data as of October 31, 2023
(Source: ACE MF, PersonalFN Research) 

PPLF typically maintains a concise portfolio comprising approximately 15 to 25 securities. As of October 31, 2023, PPLF’s portfolio was invested across 25 securities, and its top 10 holdings comprise 61.2% of the total assets.

In terms of credit quality, the fund primarily holds top-rated Government and Quasi-Government securities in its portfolio.

The latest portfolio of PPLF as of October 2023 also reveals, that 83.2% of its assets are held in sovereigns, i.e. T-bills and Government securities (G-secs), 7.3% in AAA and equivalents, 9.2% in cash-and-cash equivalents, and in the past month, an unrated Alternative Investment Fund, specifically the Corporate Debt Market Development Fund comprising 0.2% of the portfolio.

CDs currently comprise 4.9% of PPLF’s portfolio, issued by prominent banks such as ICICI Bank, Kotak Mahindra Bank, Bank of Baroda, and Axis Bank. CPs are 3.4% of the portfolio, issued by NABARD and HDFC Bank Ltd. The average maturity profile of the entire portfolio of PPLF is approximately 41 days currently.

The weighted average expense ratio of PPLF is 0.16% (for the direct plan) at present, which is lower than some of its category peers.

Parag Parikh Liquid Fund is managed by Mr Raj Mehta. He has collectively over 10 years of experience in investment research. Raj started his career with PPFAS Asset Management Pvt. Ltd. as an intern in 2012. Following this, he joined the company as a Research Analyst in 2013. He has been managing the debt component of the scheme for over 5 years now. Raj is a postgraduate in commerce (M.Com) from Mumbai University, a Chartered Accountant, and a CFA Charter holder.

PPLF while primarily focusing on high-credit-quality instruments in its portfolio, with a predominant emphasis on shorter-maturity Sovereign-rated assets, may not claim the top spot in return rankings, but has delivered reasonable returns (significantly lower exposure to interest rate and credit risks).

In my view, investors need to have a reasonable yield expectation and investment horizon while investing in this fund. PPLF is suitable for conservative investors who have a shorter investment horizon of typically between 30 to 180 days or up to a year.

Broadly, Who Should Invest in Liquid Funds?

If you are risk-averse, want to keep your hard-earned money safe, park money for the short-term, and/or wish to address contingency needs, Liquid Funds would be a worthwhile option over and above having money in the savings bank account.

Holding an optimal sum in a Liquid Fund (say, around 12 months of your regular monthly expense) shall provide you with decent liquidity. You will not have to depend on anyone in case you need cash at short notice-just as Buffett doesn’t like to depend even on his friends.

Units of Liquid Funds can be redeemed on a T+1 basis. In some cases, the instal-redemption facility is also available. The redemption value is disbursed to the linked savings bank account of the investor on a working day following the day of the valid redemption request. Keep in mind that there isn’t any exit load applicable for units held in a Liquid Fund or for 7 days or longer. For an investment horizon of up to a year, Liquid Funds are an ideal choice.

What are the Tax Implications of Investing in Liquid Funds?

All debt funds, including Liquid Funds, with effect from April 1, 2023, the capital gain arising at the time of redemption — whether short-term (a holding period of less than 36 months) or long-term (a holding period of 36 months and above) — is also taxed as per investors’ tax slab.

[Read: Debt Mutual Funds are Now at Par with Fixed Deposits for Taxation]

For NRIs, the capital gains on debt-oriented mutual funds are subject to Tax Deduction at Source (TDS) at the rate of 10% for LTCG and 30% for STCG.

If you have opted for the dividend option, for resident Indians, any dividends from Liquid Funds (under the Dividend Option) are added to the investors’ total income and are taxed according to your income-tax slab, i.e., at the marginal rate of taxation. However, if the dividend amount is more than Rs 5,000, Tax Deduction at Source (TDS) will be first done at the rate of 10%. For NRIs, the dividend received is taxed at the rate of 20%.

Finally, be a thoughtful investor, instead of considering just the absolute returns to choose the best Liquid Funds. When in doubt, speak to a SEBI-registered investment advisor.

Happy Investing!

This article first appeared on PersonalFN here