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In debt we trust

Liquid funds are emerging as a new category to park your short-term money in.

Clifford Alvares        Print Edition: July 13, 2008

After coping with the stock market’s bumpy ride for the last six months, investors have turned cautious and are shying away from the bourses. Foreign investors and high net worth individuals are waiting for a clear trend to emerge. For now, they prefer to stay in cash. Domestic mutual funds, too, have increased their cash levels to around 20 per cent recently.

Sameer Kamdar, National Head, Mutual Funds, Mata Securities
Sameer Kamdar
Perhaps you, too, have been following their footsteps and are sitting on cash. But even in this volatile market, you can make your money work for you rather than let it idle away. You can reap the benefits of being invested in safer options and draw decent returns through an innovative category of mutual funds: the Liquid Plus Funds.

This category was launched only last year after the tax rules that govern such type of funds were changed. But within a short span, the aggregate corpus of Liquid Plus Funds has surpassed the corpus of their country cousins, the standard Vanilla Liquid Funds. In fact, liquid funds used to be a popular choice with companies and high net worth individuals who wanted to invest surplus cash for a few days.

Says Sameer Kamdar, National Head, Mutual Funds, Mata Securities: “Liquid Plus Funds are becoming popular and you can see that from the higher asset base of these funds.” Even the number of funds operating in this category has increased from about 15 last year to about 28 at present.

The nick of time

For investors, there’s no better time to invest in this category than now. For one, the Reserve Bank of India’s tight monetary measures are squeezing the liquidity in the economy. Says K. Ramkumar, Head of Fixed Income, Sundaram BNP Paribas Mutual Fund: “The RBI has resorted to a combination of measures to reduce the liquidity in the economy. And this directly affects the performance of liquid funds.” Market observers also feel that the liquidity tightening measures will continue for now. Says Kamdar: “Liquid funds give higher returns when the liquidity in the economy is reducing.” Both the Vanilla Liquid Funds and Liquid Plus Funds thrive in such an atmosphere, as they invest in very short-term debt of 1-2 weeks to overnight paper.

 
Check how liquid funds have fared
Liquid Plus Funds invest in the overnight call money market and in short-term debt with tenures of a few weeks up to a year. And it’s due to this broader investment landscape that liquid funds are able to give marginally better returns than the normal liquid funds.

K. Ramkumar, Head of Fixed Income, Sundaram BNP Paribas MF
K. Ramkumar
Besides, the Liquid Plus Funds also enjoy the tax advantage of a normal bond fund. Last year, the Income Tax Act increased the dividend distribution tax on standard Liquid Funds to 28.33 per cent (including surcharge). But the Liquid Plus category enjoys a lower 14.16 per cent dividend distribution tax rate as it is considered a bond fund. As a result, an investor’s post-tax yield from a Liquid Plus Fund is far superior to that of a Liquid Fund (see Better Than the Other). Even better, investors have a relatively safer portfolio as these funds invest in debt paper with very short maturity tenures, where the default risk tends to get mitigated in a big way.

Get the horizon right

But Liquid Plus Funds carry a slightly higher risk. The average maturity of the portfolio of a Liquid Plus Fund is higher than a normal liquid fund. Last year, the difference in returns between the top and the bottom performer stood at about 108 basis points, which is a variation of about 13-15 per cent, suggesting that these funds have their own portfolio composition risk.

 
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Therefore, a sudden blip in liquidity or a change in the interest rate could affect their performance over a one- or two-week period. But over 25 days to a month, these funds perform better. Says Ramkumar: “There’s more risk in the Liquid Plus Fund category. Therefore, look at this category with an investment horizon of at least a month.” In fact, Liquid Plus Funds also charge an exit load of around 10 basis points if investors exit the fund within one week or 10 days. This discourages investors from moving out of the fund. Standard Liquid Funds don’t charge a load.

But the returns from the Liquid Plus funds more than make up for the load factor. Last year, the category returned an average of 8.23 per cent. This year, given the market conditions, the average should be better. For retail investors, if you don’t need the money over a short duration, say, 1-2 months, then, reckons Kamdar, the liquid fund category offers a potent product. In fact, you can even transfer excess cash in your savings bank account, which yields only 3.5 per cent, to Liquid Plus funds. It will comfortably double your returns with hardly any increase in the risk.

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