Liquid mutual funds: Safety and returns drive investment decision
When choosing an equity or debt mutual fund for investment, investors consider various factors such as expected returns, investment time horizon, liquidity, risks, taxation, expense ratio, etc. But, while choosing a liquid fund for investment, most people look at safety and returns as the primary factors. This blog tries to answer the question: Is liquid fund a profitable and safe option of investment?
To answer the above question, we need to first understand where liquid mutual funds invest.
Where do liquid funds invest?
Liquid funds invest in securities with a residual maturity of up to 91 days only. So, these are short-term securities with one of the highest credit ratings. Some of the securities that liquid funds invest in include:
- Treasury bills
Treasury bills are short-term securities issued by the Central Government, with a tenure of up to 364 days. Liquid funds usually invest in Treasury Bills with a tenure of up to 91 days. If the original tenure of the Treasury Bill is more than 91 days, then the liquid fund invests in it when the residual or remaining tenure is 91 days or less. Since the Central Government issues the Treasury Bills, they have the highest security or credit rating.
- State Development Loans (SDLs)
State Governments issue the State Development Loans (SDLs). They may have a tenure of more than 91 days. But, a liquid fund invests in them only when the residual or remaining tenure is 91 days or less. Since the State Governments issue these securities, the credit rating is high, and hence they provide high security.
- Government bonds
The Government bonds or G-secs, as the name suggests, are issued by the Central Government. These securities have a tenure of more than one year. But, a liquid fund invests in them when the residual or remaining tenure is 91 days or less. As the Central Government issues these securities, they have the highest credit rating and are the safest.
- Commercial papers (CPs)
Commercial papers or CPs are short-term debt securities issued by corporations. One of the objectives of liquid funds is to protect investors’ capital, and hence they invest in CPs issued by corporates with high credit ratings.
- Certificates of deposits (CDs)
Certificates of deposits or CDs are short-term debt securities issued by banks. As banks issue these securities, they are considered safe with a high credit rating.
Now that we understand where liquid funds invest let us answer whether liquid funds are a safe investment option.
Are liquid funds a safe investment option?
In the above section, we saw liquid funds invest in Central Government issued Treasury Bills (T-Bills) and Government Bonds (G-secs), and State Government issued State Development Loans (SDLs). These securities have the highest credit rating as they are backed by Central Government and State Government guarantees.
Liquid funds also invest in certificates of deposits (CDs) issued by banks. Banks are considered to be safe financial institutions. Hence, the securities issued by banks have a high credit rating. And finally, we saw liquid funds also invest in commercial papers (CPs). CPs are usually issued by corporations that have higher credit ratings.
So, overall, liquid funds invest in various securities issued by the Central Government, State Governments, banks, and corporations with one of the highest credit ratings. Hence, we can say that liquid funds are a relatively safe investment option.
Now let us answer the question of whether liquid funds are a profitable investment option.
Are liquid funds a profitable investment option?
Let us look at the returns given by liquid funds to answer this question.
Performance of Liquid funds
|Scheme name||AUM (Rs. crores)||1-year||3-years||5-years|
|Quant Liquid Plan||455||4.26%||5.54%||6.15%|
|Franklin India Liquid Fund||1,645||3.39%||4.76%||5.73%|
|IDBI Liquid Fund||890||3.46%||4.77%||5.73%|
|Mahindra Manulife Liquid Fund||1,562||3.47%||4.75%||5.72%|
|Edelweiss Liquid Fund||991||3.50%||4.75%||5.71%|
Note: The returns are as of 06th Feb 2022. The returns are for direct plans with growth option. The one-year returns are absolute. The three and five-year returns are CAGR. The funds have been ranked based on five-year performance.
The above table shows that liquid funds have consistently given positive returns. The returns are low to moderate. However, you need to understand that a liquid fund manager is more focused on protecting your capital and giving you liquidity when you need it rather than generating high returns. Keeping this objective in mind, the low to moderate returns from liquid funds are fine.
In this article, we have discussed how liquid funds invest in securities with one of the highest credit ratings. We also saw how liquid funds have consistently given profitable returns. Hence, we can conclude that a liquid fund is a profitable and safe option for investment.