Overnight funds are the new rage among investors who want safety over returnsOvernight funds are the new fad in the fixed income funds business. Assets managed by overnight funds have tripled last month after investors flocked to these funds by diverting their money from liquid and duration funds. This small category of debt schemes now manage about Rs 13,000 crore, up from less than Rs 4,000 crore a month ago.

The current demand for overnight funds brings back memories of the 2013 episode when the U.S. Treasury yields surged prompting the Federal Reserve to gradually reduce the amount of money it was feeding into the economy. In 2013 the panic spread to Indian markets too because of the global factors. But in 2018, the reason for the spurt in Indian overnight funds is entirely local – such as the IL&FS default scare and the consequent liquidity crunch in the debt markets. As a result, investors are now choosing to park their money with overnight funds. Read on to know more.

What are overnight funds?

Overnight funds provide the investors an opportunity to invest in overnight securities maturing on the next business day. So, its returns correspond to the overnight rates in the money markets. Meant for extremely conservative investors, the returns are of course accompanied by lower volatility and higher liquidity over the short term.

But aren’t liquid funds meant to do the same? Yes, liquid funds also do the same but overnight funds invest in securities with 1-day maturity, while liquid funds can invest in securities with up to 91 days maturity.

Minimum investment amount in growth option ranges from Rs 1,000 to Rs 5,000.

Who usually invest? It’s for both corporate and individuals, but corporates usually invest in them as they have short term liquidity requirements.

Who are they suitable for?

If you need to keep the money for one day and need it tomorrow, overnight funds are for you. But due to their extreme safety profile, a lot of liquid fund investors too are going the ‘overnight’ way. The fact is debt funds have come under the scanner many times. Because of their exposure to most recent IL&FS and to the past defaulters like Amtek Auto, JSPL and Ballapur Industries and so on, the debt funds are now proven to be not entirely risk-free.

What’s more worrying is liquid funds (which hold papers upto 91 days maturity) have also been impacted because of their exposure to such papers. Such credit exposure goes directly against the investor expectation from liquid funds – which is extreme safety and durable liquidity. The fact is it’s safety over returns that is the priority for a liquid fund investor.

This is why overnight funds are now emerging as a competitor or alternative to liquid funds. If regulator SEBI, as per news reports, mandates that money for less than seven days be put in overnight instruments such as CBLO (collateralised borrowing and lending obligation where money market borrowing/lending takes place on collaterised basis) and not liquid schemes, then you can expect a tsunami of fund flows into overnight funds. However, this is a speculation as of now.

Overnight funds are ideal for conservative investors looking for an alternate avenue to park their surplus fund lying idle. These investors look for a high level of liquidity for their investments. They typically have an investment horizon of a day to maximum a month.

Where do overnight funds invest?

There are less than half a dozen active overnight funds. The biggest one is HDFC Overnight Fund (erstwhile HDFC Cash Mgmt Call) with Rs 9,262 crore assets. SBI Overnight Fund (erstwhile SBI Magnum InstaCash Liquid Floater) has Rs 1,677 crore assets. L&T Cash Fund (Rs 687 crore) and UTI Overnight Fund (Rs 643 crore) are much smaller. The new fund offer of Aditya Birla Sun Life Overnight Fund closed on November 1. The NFO of ICICI Prudential Overnight Fund ended on November 15.

These overnight funds aim to generate credit risk-free return by way of income or growth by investing in central government securities, treasury bills, call money and repos. Under normal circumstances, expect at least a 65% of the total portfolio to be invested in securities issued by the central government.

Are overnight funds taxed?

Yes, they are taxed. It might be a one-night affair for you, but you have to pay taxes if there was any gain on the investment. Long term capital gains (LTCG) tax is imposed at 20% (plus surcharge, if applicable and cess) with indexation if the units held for more than 36 months. That is unlikely to happen. You will surely pay short term tax. Short term capital gains (STCG) tax is at the investor’s income tax slab rate if units are held for less than 36 months

Historical returns

Let us look at returns of the four overnight funds. One-month returns are between 0.4% to 0.5%. Three-month returns are between 1.3% to 1.6%. One year returns are between 5.4% to 6.1%.

Look at the table below to see the return comparison between overnight funds and liquid funds. We have looked at the range of funds, instead of comparing averages. Average returns are not real because they are derived from all the funds. Average returns may mask the poor performance of individual funds.

Returns comparison

Returns comparison
Category No of active schemes 1-month return 3-month return 1-year return
Overnight Funds 4 0.47% to 0.54% 1.36% to 1.59% 5.45% to 6.13%
Liquid funds 39 0.45% to 0.67% -6.84% to 1.90% -1.83% to 7.35%

We believe investors would also like to see how the rolling returns are for overnight funds. Rolling returns actually show if your fund is a consistent performer or not. The 1-month rolling return of three overnight funds (HDFC, SBI, UTI) shows that the UTI Overnight Fund did generate a negative return. We looked at rolling returns for the past five years. The maximum average return belongs to UTI Overnight Fund, but the scheme also has the lowest average return. This may be an indication of the risk the scheme took.

Take a look at the rolling return statistics below.

overnight funds rolling returns

RupeeIQ take – Before SEBI categorization rules, overnight funds were called cash funds, or cash management funds. Investors should know and understand that overnight funds are at best a sub-category of liquid funds. At present, most of the overnight funds have higher expense ratios than liquid funds. This could be due to the smaller size of the overnight funds. Once their size rises, investors should expect and demand lower expense ratios given the little or no risk the funds take (1-day maturity). If investors are okay with slightly lower returns but don’t want to compromise on safety and liquidity, overnights funds are an excellent option.

Kumar Shankar Roy

Kumar Shankar Roy is contributing editor with RupeeIQ. He can be contacted on contact@rupeeiq.com