Many of us have money idling away in a savings bank account generating meagre returns. Why not invest in Liquid funds instead?
Liquid Funds is a worthwhile investment alternative to park your short-term needs and contingency funds.
Barring a few banks, most others pay an interest of 3.5%-4.0% on balance in the savings bank account. Liquid funds, on the other hand, generate 200 to 300 basis points higher returns than what your savings bank account fetches you. A basis point is a hundredth of a per cent.
You can withdraw within a month. In other words, liquid funds offer you almost the same liquidity as your savings bank account does, but help you generate better returns.
[Read: A 3-Step Guide to Building A Liquid And Secure Emergency Fund]
So, let's understand in detail what are liquid funds and their role in your portfolio.
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Until recently, the liquid fund category was deemed as the safest mutual fund category available to investors. That's because in the past Liquid Funds rarely disappointed investors.
Thus, all discussions pertaining to the selection of the best Liquid Funds started and ended with selecting schemes that had a track record of consistent outperformance.
Financial advisers believed that the functioning of Liquid Funds was so sound that nothing could go wrong with them. Liquid Funds were even perceived to be 'safest'.
According to SEBI categorization and rationalizationnorms, Liquid Funds are mutual fund schemes investing in debt and money market securities with a maturity of upto 91 days.
They invest in money market instruments such as Certificate of Deposits (CDs), Commercial Papers, Term Deposits, Call Money, Treasury Bills, and so on. They are highly liquid in nature and entail low risk.
But the risk perception about Liquid Fund changed in 2018 after certain corporates defaulted on their short-term debt obligations.
[Read: Why Your Money In Liquid Funds Is At Risk]
What changed for the liquid funds in 2018?
enjoyed a higher credit rating before its group companies couldn't roll over their short-term debt. The company failed to plan its cash flows which resulted in it failing to honour its short-term debt obligations. A few Non-Banking Finance Companies (NBFCs) also faced the Asset-Liability Mismatches (ALM) arising from financing long-term loans/projects with short-term deposits significantly affected money market operations.
Systemic problems such as these can expose the weaknesses of the 'so-called' safe mutual fund category - Liquid Funds.
Going by the recent examples, some peculiar tendencies can land Liquid Funds, like any other debt fund category, in trouble.
[Read: Are You Holding Debt Mutual Funds With Stressed Assets?]
Liquid Funds can make you jittery if the fund manager:
Chases yields without proper risk control measures in place
Depends excessively on credit ratings assigned by external rating agencies
Understates the role of liquidity management practices adopted by the borrower
Fails to gauge the changes in the systemic liquidity conditions
Remember, Liquid funds aren't risk-free
Fund houses and distributors aggressively promoted debt funds as an alternative to fixed deposits and other fixed income products. Unfortunately, they failed to highlight the risk involved and investors had to learn the hard way. The negative returns clocked by Liquid Funds after the IL&FS came as a shocker to debt mutual fund investors.
So, while Liquid Funds are an effective medium to park your short-term needs, it is essential to recognize how Liquid Funds work, and their risk-return traits.
Who should consider liquid funds?
Liquid funds are appropriate for savers who:
Have a low-risk appetite
Want to park money for a very short-term period, typically for about 3 to 6 months
Are addressing short-term financial goals or contingency needs
Have a low tolerance for volatility, and prefer safety over returns (although some Liquid Funds could carry credit risk and hence not completely safe)
While the returns on liquid funds are generally not as high as income funds, they do seek to provide some level of stability, and can, therefore, play an important role in your portfolio. Investors can use liquid funds to offset the typically greater volatility of bond and equity investments.
How have liquid funds performed across timeframes?
On average, Liquid Funds generated 7.03% returns in 2018. Out of 36 funds considered for analysis, only six funds underperformed the category average.
Table: Top 10 performers of 2018
| Scheme Name | Returns (Absolute %) | Returns (CAGR %) | |||||
| C.Y. 2018 | 1 Month | 3 Months | 6 Months | 1 Year | 2 Years | 3 Years | |
| Baroda Liquid Fund | 7.63 | 0.54 | 1.83 | 3.75 | 7.67 | 7.22 | 7.38 |
| IDBI Liquid Fund | 7.62 | 0.54 | 1.83 | 3.78 | 7.66 | 7.21 | 7.29 |
| Edelweiss Liquid Fund | 7.57 | 0.54 | 1.80 | 3.73 | 7.61 | 7.18 | 7.04 |
| Reliance Liquid Fund | 7.57 | 0.54 | 1.81 | 3.73 | 7.62 | 7.19 | 7.31 |
| Franklin India Liquid Fund-Super Inst | 7.57 | 0.55 | 1.84 | 3.79 | 7.64 | 7.21 | 7.32 |
| Essel Liquid Fund | 7.57 | 0.56 | 1.86 | 3.78 | 7.64 | 7.25 | 7.40 |
| Mahindra Liquid Fund | 7.57 | 0.55 | 1.84 | 3.76 | 7.65 | 7.23 | -- |
| BNP Paribas Liquid Fund | 7.56 | 0.54 | 1.82 | 3.76 | 7.62 | 7.18 | 7.26 |
| DHFL Pramerica Insta Cash Fund | 7.54 | 0.56 | 1.84 | 3.75 | 7.63 | 7.19 | 7.31 |
| Quant Liquid Plan | 7.47 | 0.60 | 1.95 | 3.90 | 7.62 | 7.13 | 7.35 |
| Crisil Liquid Fund Index | 7.61 | 0.54 | 1.83 | 3.75 | 7.69 | 7.18 | 7.25 |
Data as on March 01, 2019
(Source: ACE MF)
*Please note, this table only represents the best performing Liquid Funds based solely on past returns and is NOT a recommendation.
Mutual Fund investments are subject to market risks. Read all scheme related documents carefully.
Past performance is not an indicator for future returns. The percentage returns shown are only for an indicative purpose. Speak to your investment advisor for further assistance before investing.
In Calendar Year (CY) 2018, two liquid funds namely Baroda Liquid Fund and IDBI Liquid Fund outperformed Crisil Liquid Fund Index.
However, funds such as IIFL Liquid Fund, Quantum Liquid Fund, Taurus Liquid Fund, Union Liquid Fund, Principal Cash Management Fund underperformed the category average returns over last one year.
The Best Liquid Funds for 2019
Like in the case of any other mutual fund scheme, past performance of Liquid Funds is not indicative of future performance. That said, you may consider the following schemes which have performed well over longer time frames:
- BNP Paribas Liquid Fund
- Essel Liquid Fund
- Mirae Asset Cash Management Fund
- HSBC Cash Fund
- Mahindra Liquid Fund
The above are the top-5 Liquid Funds that have shown superior performance and consistency on all parameters--quantitative as well as qualitative. The aforesaid funds have adequately compensated its investors for the level of risk taken.
[Read: Why Qualitative Aspects Are So Important To Pick Mutual Funds]
When you select best Liquid Funds for 2019, avoid schemes that haven't completed a 1-year track record in the interest of your investment portfolio.
How to pick the best Liquid Funds for 2019?
Before you invest in a liquid fund, take a deeper look at these aspects:
Concentration of portfolio
In the aftermath of IL&FS and DHFL fiascos, the concentration of portfolio has become one of the most crucial parameters to watch out for while investing in Liquid Funds. If a fund house has a tendency to invest over 5% of its assets in single debt security and 10% in instruments issued by a single private issuer, you need to be careful. Moreover, you should also be wary of fund houses investing a significant portion of their assets in group companies.
For instance, Union Liquid Fund and Principal Cash Management Fund failed to generate positive returns in the last six months due to their high exposure to troubled companies. This is what portfolio misallocations can do to liquid funds.
Average Maturity and Modified Duration
The average maturity of the debt mutual fund scheme should be low at around 30-90 days so that it is less vulnerable to interest rate movements.
The interest rate sensitivity of a bond is measured vide its modified duration.
Modified duration measures the sensitivity spectrum of the bond price in relation to a change in interest rates.
It is a vital measure for you to consider because it includes all components of a bond: price, coupon, maturity date, and interest rate to calculate the modified duration.
Therefore, the modified duration can help you recognise that a bond portfolio with a higher modified duration will have high price volatility. Thus, Liquid Funds with a lower duration will be lower risk.
Yield-to-maturity (YTM)
YTM is simply an anticipated rate of return if the bond is held until the maturity date.
It is also known as redemption yield. It measures the interest income generated by the bonds in the portfolio.
YTM takes into account the current market price, the face value, the interest payment that will fall due on the bond, and years left in its maturity.
YTM can be used as an approximate measure of the returns that a fund can generate over its average maturity period.
Cutting back excessive reliance on credit rating agencies
As you may know, debt instruments in India are rated on the basis of their creditworthiness by variouscredit rating agenciessuch asCRISIL,CARE,ICRA, amongst others.
Hence, credit ratings for debt instruments in the portfolio of a debt mutual fund scheme can throw some light on the qualitative aspects as it helps you assess the credit risk.
If the portfolio consists of securities with the highest credit rating, it implies that the portfolio's exposure to default risk is lower.
However, that doesn't mean one should rely solely on credit ratings. If you recollect, IL&FS, DHFL, Amtek Auto, all enjoyed high credit rating until credit rating agencies were caught napping.
Will anything change for liquid funds in 2019?
As reported by the Economic Times dated January 16, 2019, there's been a buzz in the industry that SEBI might directmutual fundsto invest a minimum portion of their assets in government treasuries. It's also anticipated that the capital market regulator might impose stricter valuation norms and might even impose a minimum lock-in period requirement for investors ofliquid funds.
SEBI has already directed liquid funds to mark-to-market all securities with a residual maturity of more than 30 days through a press release dated March 01, 2019. Earlier the limit was 60 days.
This was a suggestion of Mutual Fund Advisory Committee (MFAC) appointed by the capital market regulator.
Other recommendations were:
Liquid funds should have a lock-in period of seven days for liquid funds.
Liquid funds should invest at least 15%-20% of their AUM in government treasuries with residual maturity of 91 days.
If SEBI accepts these recommendations then the fundamental principles guiding investments in liquid funds might change.
Key takeaways for investors inliquid funds...
You may invest in Liquid Funds to clock better returns than on a savings bank account. However, do not assume that Liquid Funds are absolutely safe; they are not risk-free. When investing in Liquid Funds the safety of your hard-earned money should be your foremost concern rather than returns.
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Author: PersonalFN Content & Research Team
