Liquid Fund was earlier a preferred Mutual Fund (MF) category to park brief-term income as such funds used to provide returns comparable to bank FDs with improved liquidity and indexation positive aspects on lengthy-term capital achieve.
“Liquid funds are a specialised form of mutual funds that invest in extremely short term fixed instruments with a maturity of 91 days. These funds are ideal for corporates, institutional investors and business houses that park large sums for a very short period,” mentioned S Ravi, former Chairman of Bombay Stock Exchange (BSE) and Founder and Managing Partner, Ravi Rajan & Co.
However, from about 7 per cent annual return (CAGR) about a year ago, the returns on Liquid Fund schemes have fallen to under 4 per cent, hence forcing retail investors to shift to other categories of funds.
But why have the returns (CAGR) on Liquid Funds dropped?
“The returns from liquid funds have dropped as the Reserve Bank of India (RBI) has gradually reduced interest rates over the last few years – from 6.5 per cent in January 2019 to 4 per cent in May 2020. Several unprecedented measures by RBI to increase liquidity (read as to make money easily available for banks to lend) during the pandemic have led to liquid fund yields and returns dropping much below the repo rate close to the reverse repo rate at 3.35 per cent as liquidity continues to remain in excess,” mentioned Arun Kumar, Head of Research, FundsIndia.
Apart from the RBI’s stance to inject liquidity to revive the economy, Ravi also cites the dangers that Liquid Funds face lately.
Mutual Fund Investment: Should you do asset allocation your self or opt for hybrid funds?
“Default risk and interest risk have dented returns of liquid funds, Despite knowing the credit history of the Yes Bank, DHFL, etc some fund houses took a chance, impacting the credit ratings which has led to a decline in the NAV as well,” mentioned Ravi.
“Further, the virtual forms of credit extensions have had a carryover effect on other banks’ credit ratings, thus making liquid and debt funds riskier and in some cases a loss-making instrument,” he added.
With returns dwindling under 4 per cent, only corporates and other investors – for whom liquidity is more crucial than return – now park their income in Liquid Funds.