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B. Venkatesh

PRINCIPAL Cash Management Fund Liquid Option generated an annualised return of 4.9 per cent in the last six months. The returns are on par with interest rates on six-month bank fixed-deposit. Investors who prefer exposure to various short-term fixed-income instruments can consider buying into this fund.

Portfolio: The fund scores on two counts — portfolio diversification and liquidity. A bank fixed-deposit will earn a fixed rate of return till the maturity of the deposit. This means that the investor cannot reap higher returns should short-term interest rates rise during the life of the deposit.

Principal Cash Management Fund has exposure in floating rate instruments and call money to take advantage of any increase in short-term interest rates. Take the call money market, where the fund lends to banks and primary dealers for periods of one to 14 days. If short-term interest rates rise, the fund can re-lend the proceeds at a higher rate.

There is of course a risk-return trade-off. The fund is subject to higher reinvestment risk than a bank fixed deposit. This is the risk of earning lower returns because of decline in short-term interest rate. What if the fund cuts its exposure to T-bills and lends more in the call money market, and short-term interest declines subsequently?

So, each time the fund suffers from reinvestment risk, its monthly returns will decline. And that will lead to fluctuation in the monthly returns. But past record shows that the month-on-month returns have been fairly stable; the difference between the highest and lowest monthly return in the last six months is only one-sixteenth of one per cent.

This suggests that the reinvestment risk is not higher than the bank fixed deposit. Note that the possibility of low re-investment risk applies only to investors who continually maintain a proportion of their total investment portfolio in this fund instead of holding the amount in short-term FD or savings bank account.

Another advantage is that the fund's NAV is computed on an accrual basis. That is, interest earned on the money market instruments is added to the NAV on a daily basis. So, nominal returns for unit-holders cannot be negative, similar to bank fixed-deposits, as long as the fund continues to invest in instruments with maturity of less than six months.

Finally, the fund offers easy exit option compared with a bank fixed deposit. True, investors can borrow a portion of their deposit, but that carries a cost in the form of a higher interest rate. Liquid funds, on the other hand, do not charge any entry and exit load. This makes it easy for unit-holders to change their investment horizon.

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