LIQUID FUNDS

A lucrative means of parking money for the short term and earning reasonable returns is to invest in liquid funds.

Liquid funds are ultra short-term debt funds that invest in money market instruments such as certificate of deposits, commercial paper and treasury bills, either on an overnight basis, ten days or a month. We present an analysis of liquid fund investing.

Liquid funds have no entry and exit loads in most cases. Compared to savings accounts, where the returns are as low as 4% per annum, the historical returns on liquid funds have been as high as 8% per annum.

Moreover, liquidation is easy. Investors can liquidate at an NAV (net asset value) which they consider to be lucrative, as against a normal mutual fund where an NAV just has a notional value. These funds require a minimum investment of Rs 1,000. However, some funds have a minimum investment requirement of Rs 5000-10 ,000 or Rs 25,000.

There are two kinds of liquid funds. One is a pure liquid fund and the other is liquid plus. The main difference between pure liquid and liquid plus funds is the tenure of the securities held. The instruments held by liquid plus funds have a longer tenure than liquid funds. In terms of tax implications, there is a dividend distribution tax of 28.33% on liquid funds, whereas 14.16% is levied on liquid plus funds (in case of individual investors).

In the past five years, liquid funds have given 6.41% returns. LIC MF Liquid Fund, the best performing fund, has given returns of 4.62% in the past six months and may give annualised returns of 9.2%.

A fixed deposit, that gives returns of around 9%, entails long-term capital gain tax of 33% (excluding the surcharge of 10%), while investing in a dividend option of a liquid fund, with maturity of up to a year, entails a dividend distribution tax of 28.33%, which is better than post-tax returns of an FD.

Liquid funds witnessed huge redemptions last year. But they still provided returns in excess of 8% during the period.

Given their resilience, these funds can come in handy for parking short-term money. One needs to, however, be cautious about the quality of papers and instruments. Last year, some funds invested in papers issued by real estate companies, whose defaults resulted in huge redemptions.