The Buyt Desk
Overnight funds are the safest debt funds with overnight maturities from investing in debt securities and carrying minimal credit risk and zero interest rate risk.
What does Overnight Funds mean?
Overnight Funds are defined as a kind of open-ended debt scheme that invests in overnight maturing debt securities i.e. the very next business day. The securities in the portfolio mature every 24 hours. The proceeds are used by the fund manager to buy new securities for the portfolio which mature the next day. Like other debt funds, these funds do not have to bear any kind of interest rate risk or default risk as maturity is just a day for the securities in these funds. The safest of all mutual funds is Overnight funds. And for new investors in the world of mutual funds who want to try out mutual funds before getting in full-fledged, then overnight funds are for them. As it is a low-risk profile, it is safe to play but it implies that returns are low compared to other long-term investments.
Who are the Participants in an Overnight Fund transaction?
Overnight Fund transactions happen through four entities.
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Lenders – The investors in overnight funds are known as lenders. These may be banks, institutional investors, retail investors or other institutions.
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Mutual Fund house – This is an entity in which people have invested their money. This fund house lends the received amount at a fixed rate of interest.
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Borrower – A person or institution who loans the money at fixed rate of interest from the mutual fund house is the borrower. And the bank is one of the primary borrowers.
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CCIL – The Clearing Corporation of India Limited is an institute in charge of the matchmaking of lender and borrower. It is CCIL’s responsibility to settle the transactions overnight.
Why should one invest in Overnight Funds?
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Liquidity – These invested securities have a one-day (overnight) short residual maturity and this makes it highly liquid.
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Flexible holding period – Here the investor can hold their invested securities for the duration of their choice. Overnight funds make it easy to enter and exit the market while still earning safe returns for the time period of the investment.
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Low-risk factor – Here the risks of credit or default are mitigated due to a short period (overnight) of lending and thus this is the best choice for investors with a low-risk appetite.
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Low cost – Overnight funds are one of the very few low-cost debt funds as their debt holdings need not be managed actively and thus operated with expense ratios below 1%.
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Less volatility – Here the bonds mature overnight (just a day) and hence they are less volatile
Why should one not invest in Overnight Funds?
People should avoid investing in overnight funds because of very low returns on the investment made. Because of low risks and high liquidity, returns will be very less. Inflation rate is very high and in such situations getting low returns is not acceptable. But if one has a very low risk appetite and very short parking period, then this is the only option.
Who should invest in Overnight Funds?
Overnight funds are ideal for investors having a very small investment horizon and who need medium to direct investments in Equity funds. Overnight funds are best made for the businessmen and entrepreneurs who all the time need to park their large funds for very short periods of time before investing elsewhere. The money will be lying idle in a current bank account, so the better idea is to invest surplus cash in an overnight fund and earn some returns, even for short duration. They are also ideal to invest your set aside Emergency Funds in overnight funds as your money will be earning some interest while still handy since it offers the highest liquidity.
What are the things to consider before investing in Overnight Funds?
Even though Overnight funds are considered safest there are few things to look into before investing. Overnight funds are not intended to increase returns but are like savings accounts, where money is safe and easily withdrawn. Overnight funds offer low returns compared to other mutual funds. Here the investor must compromise on returns as it has a high safety and liquidity component. Be a smart investor and allocate only a portion of your funds to overnight funds just to avoid risk. When risk appetite is small but investment prospects are longer, about 3 to 6 months then liquid funds or ultra-short duration funds that hold high-quality bonds are better options to earn better returns.
What are the Taxations of Overnight Funds?
Overnight funds are taxed like any other debt fund. Invested securities of overnight funds that are held for less than three years are considered for short-term capital gains (STCG) tax, where investors are taxed as per their income slab. And for invested securities of overnight funds that are held for more than three years are considered for long-term capital gains (LTCG) tax at the rate of 20%, where investors have the benefit of indexation. However, the classical method of taxing dividends is followed here too. The dividends earned through overnight funds are taxable as per the investors’ tax slab.
Summing up
Investors can make the most of the overnight funds when they understand they understand the complete working of these funds. Also study the market well when it comes to debt fund investments to make better profits. Overnight funds are best suitable for investors having a very short investment period and low risk appetite. Overnight funds offer liquidity, safety, security, sustainability and flexibility of withdrawal and are likely to earn higher returns compared to bank savings deposits. It can also be used as a medium to route funds into other long-term funds.
