Hello Readers!
Liquid Funds is a debt fund with the shortest investing period of 91 days, they are considered as the least risky funds and the best place to park your idle cash. Like other equity funds, debt funds also have suffered from this pandemic badly, not directly but indirectly.
It has been observed that the growth rates of liquid funds for the last few months, is trending lower than the usual 6%-7% which was seen a year ago. The lower growth rates of liquid funds are making many investors confused regarding their investments. They are confused about what is the need of the hour, and what they should do.
Well, let us know the reason behind the trending low growth rates in Liquid funds.
Reason number 1: Cut In Repo And Reverse Repo Rates
In order to support the economy of India, in this time of economic slowdown that followed the pandemic and the resultant lockdown, RBI (Reserve Bank of India) cut down the repo and reverse repo rates, periodically. In May 2020 RBI has reduced Repo Rate by 40 bps. This meant that the Repo Rate reduced from 6% to 4% within one year.
The cut in repos rates affected the yields from instruments like treasury bills and government securities, where many of liquid funds invest. The returns from these instruments declined, while in some cases it declined more than the cut by RBI in repo rates.
The cur in repo rates and the abundance of liquidity in liquid funds led to the sharp fall in the interest rate and resulted in the lower growth rate for liquid funds.
Reason Number 2: Change of Risk Profile in Liquid Funds
In the year 2019, SEBI brought some mandatory changes in the investment strategy of liquid funds keeping it concerned with the Risk Management Framework for Liquid Funds. As per SEBI, it was mandatory for liquid funds to invest 20% of net assets in Liquid Assets. These Liquid Assets include Cash, T-Bills, Government Securities, and Repo on G-Secs.
The instrument mentioned, are least risky in nature and gives higher safety, but at the same time, the yield from these instruments is on the lower side. Furthermore, Liquid Funds were restricted from using the Short-Term Deposits as a channel for investment too. This resulted in Liquid Funds seeing a drag in returns.
With the mandating rule of 20% investment in liquid assets, the fund managers of liquid funds get more inclined towards the investing strategy that focused mainly on reducing the credit risk from the investment.
Will This Last Forever?
In the market and economy, nothing is permanent and nothing lasts forever. The RBI’s decision regarding cut down in Repo rates is short-term, taken especially to support the economy in this hard time. As interest rates go up, so will yield to maturity of instruments liquid funds invest in.
What Should The Investor’s Do?
Liquid Funds are still taken as the safest choice to park your idle cash. It is the best solution for those who are looking for funds with the stability and security of capital.
Liquid funds continue to give better returns than compared to the savings bank account, taking into consideration that the bank savings account rates have also been trending lower (SBI: 2.75%) for the same reasons as liquid funds.
Bank FDs are also subject to the same RBI decisions on interest rates that liquid fund investments are subject to, resulting in a similar declining trend of returns. Instead, Liquid funds are comparably a better investment than FD’s, taking in consideration that it offers the liquidity and post-tax benefits.
So basically, instead of this short-term growth trend in Liquid funds, it is suggested adding Liquid fund in your portfolio for a short-term money investment plan. We also suggest you can go investing in Ultra-short-term and short-term duration funds where the priority is the security of capital while giving you better returns than FD over a period of 1-5 years.
For any kind of query, you can contact us at Shri Ashutosh Securities Pvt Ltd., we are here to help you in any way possible.
Happy Investing!
(Mutual Fund investments are subject to market risk Illustrations are for example only, there is no guarantee of returns. Past performance is not an indicator/guarantee to future returns).