A liquid fund is a debt mutual fund scheme. You invest in it if you have excess cash at bank and think you might need the cash in a few days or weeks or months. Instead of parking your cash in a savings bank or current Account, why not put it where it fetches higher returns?
A liquid fund is such an option where risk is very minimal although not completely absent.
If you wish to invest a large sum in an equity fund, but want to stagger the investments over a period, put your money in a liquid fund and enroll for a systematic transfer plan (STP) whereby you invest a fixed sum from your liquid fund to an equity fund each month.
As per rules laid down by the capital market regulator, Securities and Exchange Board of India (Sebi), if a security matures in under 60 days, it need not be marked to market. Just the interest component needs to be added. In simple words, whatever interest your debt fund earns through the tenure of a security, it will divide the total interest component equally for the number of days it holds the security. The security's price remains steady. Hence, your liquid fund's NAV movement is linear; think of it as a steady line going up. Liquid Funds typically invests in Money market debt securities that mature up to 91 days and not more.
Liquidity is just one working day. That means you can invest and redeem your funds the same day earning you a interest for one day and they don't charge any exit load either. Liquid funds generally have very low management fees which are stated as expense ratio about 0.15% pa (for direct funds).
Mutual fund companies offer two kind of Liquid funds called pure Liquid fund scheme and Liquid Plus scheme. The later one is generally called floating rate funds or money market schemes. As per the new SEBI regulations on debt funds reclassification, a AMC can have only one Liquid fund and name 'Liquid' or 'Cash' need to be stated in the fund name. AMCs which had multiple pure liquid funds now converted the floating rate or money market funds to Liquid Plus category though the investment strategy Liquidity and expense ratios remains the same.
But it is very important for investors to know the difference between pure Liquid funds and Liquid Plus category. The difference is in the treatment in processing while purchasing and redemption. Liquid funds provide historical NAV while purchasing and benefit of weekend NAVs.
When you purchase a Liquid Fund by transferring funds before cut off time of 2 pm, you will get previous days NAV. That means if your funds are utilized today for investing in a liquid fund, you have already got an appreciation of one day interest as funds are invested at previous day's NAV and not today's closing NAV.
Suppose you are redeeming your liquid fund investment a day before debt market holiday, say Friday you will only get the funds on next working day, i.e. Monday in this case. In liquid fund, redemption is done on Sunday though it is processed two days earlier. That means you will get interest for 2 holidays, Saturday and Sunday in this case. This is called weekend NAV benefit and only pure Liquid funds provide you this benefit and not Liquid Plus category schemes. To make you understand this concept let's go through a simple illustration by taking example of Aditya Birla Liquid Fund a pure Liquid fund and Aditya Birla Money Manager fund which has now categorised as Liquid Plus scheme.
In Pure Liquid Fund Purchase Transaction -When amount is received in the bank account of the AMC before 2 pm on the purchase day, Units are allotted based on previous day NAV.
In this illustration when Purchase transaction is done on Friday before cut off time, Amount is invested on Thursday's NAV.
When funds are redeemed on Next Friday, Redemption proceeds are received on Monday but Investor will get the NAV of Sunday thus benefiting from the appreciation of Saturday and Sunday. This will result in higher annualized returns for the investors parking the money for very short period of time.
In this illustration Funds are invested in pure liquid fund for 10 days, but investor is getting the benefit of 11 days appreciation including the weekend holidays.
Funds which are invested in Liquid Plus category scheme for 10 days but investor is getting the benefit of only 8 days of appreciation.
The differential earning is 1.71% pa over Liquid plus category scheme.
Always make a well informed investment that suits your investment objective and choose funds accordingly. Happy investing.
Prabhakar Kudva, is Co-Founder and Director of Samvitti Capital, a Karnataka based Asset Management Boutique