Starting from instant noodles to instant money transfer, instant is the new normal—the need of the hour. Why should the money market hang behind? If you want to redeem their money from the market almost instantly, the Securities and Exchange Board of India (SEBI) has introduced a new type of debt funds called overnight funds in 2018.
Ever since there has been a rising demand for overnight mutual funds among those who have a very short investment horizon. These funds are also widely known for being investor-friendly, where you buy mutual funds today and sell them tomorrow.
What are overnight mutual funds?
Overnight mutual funds are a type of open-ended debt funds where you invest your money primarily in overnight assets and securities. You, as an investor, can simply enter and exit an overnight mutual fund within the trading session (9.15hrs-15.30hrs). When a business day begins, the funds are held in cash. Your fund manager invests in bonds that mature the very next day, that is, matures overnight. This may go on in a circle.
How do overnight funds function?
The two most important aspects as far as overnight fund operation is concerned are as follows:
- Where to invest
According to SEBI, you can only invest in funds and assets that mature in one day, like collateralized borrowing and lending obligations (CBLOs), overnight reverse repos and other debt/ money market securities. An overnight fund portfolio undergoes changes every single day, incorporating new overnight securities. Here, you cannot invest in deposits or risky debt instruments. The overall asset holding of such a fund is categorised as “Cash and Cash Equivalents”.
- How to earn
The securities that the fund holds mature overnight. Hence, you cannot earn capital gains by investing in overnight mutual funds. Here, you only receive the interest paid on your debt holdings. Returns on overnight funds show the lending and borrowing rates generated in one day. The rates and conditions in the overnight market for funds determine the returns of overnight funds.
Features of overnight funds:
The main objective of an overnight fund is to help investors put the excess cash to better use without risking too much. The following features of this fund help achieve this goal:
- Very short investment horizon
- The significantly low exposure to risk
- Buy and sell funds in no time leads to high liquidity
Why trade in overnight funds?
Is it a good time to invest in mutual funds when the market is more volatile than ever? The answer could be yes if it is an overnight fund, because:
- When you invest in securities that mature overnight, you do not make any capital gain or loss. Also, these securities hardly renege on interest payments. Hence, their credit risk is almost nil. If you have a low-risk appetite, overnight funds are the best mutual funds to buy now.
- A majority of the overnight funds incur an expense ratio below 1%. They are, therefore, considered low-cost.
- With overnight funds, you are free to enter and exit the investment at your convenience. It, thus, offers flexibility.
So, if you have a query, is it a good time to invest in mutual funds you need to do your research properly.
Who trades in overnight funds?
You may want to buy mutual funds that mature overnight if you:
- have a very short investment horizon
- want a risk-free breathing space before you shift investments to equity funds
What are the best mutual funds to buy now?
In case you aren’t sure what are the best mutual funds to buy now, the following criteria may help you choose:
- A week’s or a month’s return performance of the fund
- The less the expense ratio the more the return
Overnight funds and taxation:
Tax levied on overnight funds is similar to that of debt funds. If the fund is given up before the completion of three years, the units of that fund are subjected to short-term capital gain tax. In case the fund is held for more than three years, the units are subjected to a long-term capital gain tax at 20%. Dividends are taxed based on income bracket.
Conclusion: Overnight funds allow investors to utilise the excess cash that they have at their disposal in a better and more cost-effective way. However, the only factor to invest should not be your consideration if is it a good time to invest in mutual funds. You can invest in overnight funds if you wish to park it for a short period, even if that means for a day or the weekend only.