Liquid Funds Vs. Overnight Funds: Which is Better?

Do you know what is the difference between Liquid fund and Overnight fund? In this post, we discuss what is overnight fund and how it differs from a liquid fund?

What is an Overnight Fund?

Overnight Fund is a category of debt funds in which the fund only invests in overnight securities having maturity or residual maturity of just one (1) day. These funds have extremely low (almost negligible) chances of default and due to the short-term nature (1 day) of securities/papers, the interest rate risk and credit risk is also almost zero. Typically, the funds invest CBLOs, treasury bills, certificates of deposit and commercial papers with residual maturity of not more than one day.

What is a Liquid Fund?

Liquid fund is a category of debt fund that invests in debt and money market securities with maturity of up to 91 days. These generally include certificates of deposits, commercial papers, treasury bills and other instruments that mature within 91 days period.

As of the current rules of SEBI mutual fund categorization, SEBI doesn’t define the credit quality of the papers that a liquid fund can hold. So fund managers are free to take as much credit-risk as possible though the prudent fund managers of liquid funds wouldn’t do that. But at times, some adventurous fund managers try to invest in lower quality papers in search of additional returns. It is best to avoid such funds.

Difference between Overnight Funds Vs. Liquid Funds

• Both liquid funds and overnight funds are open-ended debt funds.
• Overnight funds invest in papers with residual maturity of 1 day while liquid funds invest in papers of maturity less than 91 days.
• Overnight funds have almost nil interest rate risk or credit risk. Liquid funds have interest risk but can have varying levels of credit risk and default risk depending on the underlying papers in the fund’s portfolio.
• So liquid funds are riskier than overnight funds. But liquid funds are less riskier than all other debt fund categories.
• Liquid funds give better average returns than Overnight funds. But it must be noted that overnight funds are more for temporary parking of funds with adequate liquidity and negligible risk and hence, return is not the driving factor for overnight funds.
• There is no exit load on selling overnight funds. But there is graded exit load in liquid funds if sold within the first 6 days. The exit load ranges from 0.007% on the first day to 0.0045% on the sixth day from the date of investment. There is no exit load from the seventh day onwards.

This is how Overnight Funds are different from Liquid Funds in India.

So how to choose between liquid and overnight funds?

Few things to note before you decide which is better in liquid funds or overnight funds.

Overnight funds are currently more suitable for institutional investors looking to park large amounts of money for very short periods (at times just a few days) with negligible risk. Most common investors are generally investing for longer than a few days and hence, can consider parking money in liquid funds instead (assuming liquid funds are carefully selected). A conservatively-managed well-chosen liquid fund that holds securities of highest credit quality will take care of the credit and interest rate risk to a large extent and deliver earn better returns than overnight funds. Liquid funds and overnight funds are good alternatives to savings account (and at times to bank FDs as well).