Liquid funds turn attractive after interest cut by banks

Chennai: With several banks cutting the interest on deposits in savings accounts to 3.5%, liquid mutual funds (MFs) have become an attractive proposition. Though the returns from liquid schemes have moderated to 6.25%-6.5% over the last five months compared to 6.5%-7% gains recorded over the last one year on the back of a decline in repo rates, they offer higher pre-tax and post-tax returns than savings deposits on an annualised basis.
These schemes provide 2.75%-3% higher pre-tax returns and 0.9%-1.6% higher post-tax gains, on an annualised basis, than savings accounts.Though fixed deposits (FDs) of leading banks such as SBI offer similar returns, the two categories are not strictly comparable. Bank FDs are essentially lock-in products and premature withdrawals attract penalties.
While liquid MFs, like other MFs, are subject to market risks, the shorter maturity profile of the underlying investments of around 1-2 months and the high credit quality of the underlying portfolio, which comprises money market instruments like certificate of deposits (CDs), treasury bills (T-Bills), and high-rated commercial papers alleviate credit risk to some extent.
“With the arbitrage between liquid mutual funds and bank deposits likely to continue, the pace of incremental inflows into liquid mutual funds is expected to increase over the near to medium term as some part of the surplus funds are moved away from bank deposits as investors look to improve returns without taking too much risk,” said Karthik Srinivasan, senior vice president and group head, financial sector ratings, ICRA.
Retail customers use saving accounts for parking liquidity, and not as an investment option. Given the ready liquidity, ease of use, and their linkage with the banking system, savings accounts act as the most prominent tool for liquidity management for retail investors.
“With this reduction in savings rate, it is likely that liquid funds, which offer the advantage of liquidity and flexible maturity with easy redemption, could gain prominence as an alternative tool,” ICRA said. Liquid MFs are debt funds where the pooled capital is deployed in liquid money market instruments like CDs, T-Bills, commercial papers and term deposits with a residual maturity of less than 91 days.
“In accordance with markets regulator SEBI’s regulations, securities with maturity of less than 60 days are amortised on a straight line basis to maturity from cost or last valuation price lending greater stability to the scheme NAVs (net asset values),” ICRA said.
These funds do not have a lock-in period and also allow instant redemption. Liquid funds are typically used by corporates, institutional investors and business houses for deploying surplus liquidity for a short duration (a day to three months).
The monthly average assets under management of liquid MFs increased at a CAGR (compounded annual growth rate) of 20%--from Rs. 2.93 lakh crore in June 2015 to Rs. 4.19 lakh crore at the end of June 2017.
“The features such as no lock-in period, real-time credit of redemption amount in bank account, subject to certain conditions help allay concerns regarding liquidity for such schemes when compared to savings deposits,” ICRA said.