Liquid Funds are probably the most invested mutual funds in India.
While equity mutual funds are the most popular among retail investors, most corporates invest in liquid mutual funds. This is because liquid mutual funds are among the safest category of mutual funds out there.
What are liquid funds?
Liquid funds invest in securities that mature within 91 days or 3 months.
This subjects them to very little interest rate and credit risks. Interest rate and credit risks are the two risks that affect different debt mutual funds with varying degrees.
Also, historically, liquid funds have had a very low volatility. In simple terms, liquid funds have a low risk-low return profile.
Here’s a primer on debt mutual funds for those who want to know more about them
So, now we know that liquid funds –
- Invest in securities that mature within 91 days
- Have negligible interest rate risk
- Have negligible credit risk
- Have a low volatility
- Have zero exit load? They used to have a zero exit load!
Exit Load on Liquid Funds
Until recently, liquid funds were free to be exited whenever the investor desired!
The low risk profile and penalty-free exit made liquid funds very attractive for short term deposits.
This was because, historically, the returns on liquid funds have been around the interest rate on fixed deposits.
But investing in fixed deposits came with a caveat – a penalty on premature withdrawal. Moreover, one would have to visit the bank to close the fixed deposits. Liquid funds, on the other hand, were easy to exit without any penalty. And you could invest and redeem in liquid funds online as well!
Learn how to invest in mutual funds online
But SEBI has made the redemptions on liquid funds restrictive. You can no longer redeem from liquid funds without implications.
What are the implications?
Here you go –
For redemptions and switch-outs beyond the 6-day mark, the exit load is nil.
A lot of readers by now would be scoffing at these measly exit load numbers!
Well, I wouldn’t invest in a liquid fund if my investment horizon was less than 3 days anyway. So, assuming I invest Rs. 50,000 in a liquid fund and redeem after 5 days, assuming no growth in my investments, the exit load would be Rs. 2.5! I am okay with that!
And honestly, most retail investors will be okay with this structure. The real problem is faced by the most active liquid fund investors – corporates!
A corporate doesn’t invest a few thousands or lakhs in liquid funds – they invest tens and hundreds of crores! The new exit load structure on liquid funds is meant to hurt corporates.
The idea is to keep the constant inflows and outflows in liquid funds by corporates under check. These constant flows could hurt other smaller investors and this directive is aimed at protecting them.
What are the likely effects of exit load on liquid funds?
Corporates will flock to overnight funds
Corporates need liquidity with security. Overnight funds are the safer version of liquid funds.
Overnight funds invest in securities with a maturity of just a single day.
However, they will have to take a hit on the return prospects of their holdings. The returns generated by overnight funds are slight lower than that generated by liquid funds.
Protection for retail liquid fund investors
If the expected transition of large corporate investors to overnight funds indeed takes place, this will make liquid funds safer for the smaller retail investors.
This is because the constant flows in and out of liquid funds would stop and the returns impact due to it will be minimized.
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