Personal Finance

A safe short-term option

Dhuraivel Gunasekaran | Updated on July 14, 2019

Overnight funds have low risk and generate moderate returns

 Investors wanting to park their idle money for a short term, say, for a day to a month or to manage their emergency funds can consider investing in overnight funds.

Overnight funds generate moderate returns commensurate with relatively low risk and higher liquidity, and are preferred to savings bank accounts and liquid and arbitrage mutual funds.

With instances of credit-quality downgrades and defaults in the bond market, overnight funds are gaining attention as a safe option. Recently, SEBI mandated the liquid funds to follow only the mark-to-market method of valuation while computing NAVs. This may create the room for the fund managers to maintain the portfolio average maturity around 70-90 days to take advantage of steepness at the extreme short end. This will, in turn, improve the returns of the liquid funds while increase the volatility. SEBI also introduced 7 days exit load in liquid. So investors who want to hold for very short term may prefer the overnight funds.

Now, 19 funds are available under the overnight funds category. Most of them, however, have an NAV track record of less than a year. UTI, ICICI Prudential, Reliance, SBI and DSP are some of the top- performing funds. However, overnight funds are not suitable for long- term investments.

Investment strategy

Overnight funds invest in securities with residual maturity of around one day, such as repo, tri-party repo (TREPS), certificate of deposit (CD), commercial paper (CP), Treasury Bill (T-Bill) and cash management bill. But mutual funds prefer TREPS as it enables efficient short- term borrowing or lending.

In simple terms, a participant in TREPS can borrow and lend for the short term (one day to a year) by using government securities and corporate bonds as underlying collateral. Overnight funds participate as a lender in TREPS.

Currently, repo in government securities is being allowed through the Clearing Corporation of India (CCIL) platform with a tenor of one day to a year. The daily average volume in TREPS is around ₹1.5 lakh crore.

The NSE and the BSE allow repo in corporate bonds. The minimum tenor is one day and the maximum allowed on the NSE and the BSE are seven and 10 days, respectively. However, most overnight funds do not prefer repo in corporate bonds.

Overnight funds carry very low credit risk as the default risk in the TREP transactions is very low. Eligible participants can take part in these transactions, as directed by SEBI and the RBI; hence the counter-party risk is minimal. The underlying collateral securities are mostly G-Secs and highest-rated corporate bonds. Since these transactions mature in and around one day, they eliminate the interest rate risk also.


The returns generated by the overnight funds are lower among the mutual fund categories. The rates or yields offered by the short-term debt instruments are mostly based on the liquidity condition in the market. However, the yield would always be below the RBI’s repo rate; currently, this stands at 5.75 per cent. So, the return generated by the overnight funds could be around 5.75 per cent.

Though called overnight funds, most funds maintain the portfolio average maturity at around three days. The data compiled from CCIL shows that the difference in the rates among the TREP maturing in one and seven days is around 10-30 bps.

The annualised one-day rolling return compiled from the ACEMF shows that the overnight funds category has delivered returns ranging 5.3-6.5 per cent over the last one year. On pre-tax return basis, these returns are higher than the savings bank rates and FD rates.

Under the growth plan in the overnight funds, selling the units within 36 months attracts short-term capital gain tax, which is taxed as per the investor’s tax bracket. Under the dividend plan, the AMC deducts 29.12 per cent as dividend distribution tax (DDT) on the dividend declared for retail and HNI investors.

It is worth noting that certain banks offer 5-6 per cent rates of interest in their savings account. Savings accounts score better from a tax perspective; interest up to ₹10,000 is exempt under Section 80TTA of the IT Act. So, idle money of over and above ₹2 lakh can be parked in overnight funds. Overnight funds can be considered for Systematic Withdrawal Plan (SWP) and Systematic Transfer Plan (STP) transactions.

As directed by SEBI, most liquid funds facilitate instant redemption of ₹50,000 or 90 per cent of the folio, whichever is lower. The amount will be credited to your bank account once the redemption request is made. This facility is not available with overnight funds. Normally, in overnight funds, the investors can redeem on the next business day (T+1 basis).

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Published on July 09, 2019
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