Liquid Funds, as the name suggests, invest predominantly in highly liquid money market instruments and debt securities of very short tenure and hence provide high liquidity. They invest in very short-term instruments such as Treasury Bills (T-bills), Commercial Paper (CP), Certificates Of Deposit (CD) and Collateralized Lending & Borrowing Obligations (CBLO) that have residual maturities of up to 91 days to generate optimal returns while maintaining safety and high liquidity. Redemption requests in these Liquid funds are processed within one working (T+1) day.
The aim of the fund manager of a Liquid Fund is to invest only into liquid investments with good credit rating with very low possibility of a default. The returns typically take the back seat as protection of capital remains of utmost importance. Control over expenses in the form of low expense ratio, good overall credit quality of the portfolio and a disciplined approach to investing are some of the key ingredients of a good liquid fund.
Most retail customers prefer to keep their surplus cash in Savings Bank deposits as they consider the same to be safest and they could withdraw the money at any time. Liquid Funds and Money Market Mutual Funds provide a more attractive option. Surplus cash invested in money market mutual funds earns higher post-tax returns with a reasonable degree of safety of the principal invested and liquidity.
Liquid funds are preferred by investors to park their money for short periods of time typically 1 day to 3 months. Wealth managers suggest liquid funds as an ideal parking ground when you have a sudden influx of cash, which could be a huge bonus, sale of real estate and so on and you are undecided about where to deploy that money. Investors looking out for opportunities in equities and long-term fixed income instruments can also park their money in the liquid funds in the meantime. Many equity investors use liquid funds to stagger their investments into equity mutual funds using the Systematic Transfer Plan (STP), as they believe this method could yield higher returns.
Liquid Funds typically do not charge any exit loads. Investors are offered growth and dividend options. Within dividend option, investors can choose daily, weekly or monthly dividends depending on their investment horizon and investment amount. Redemption payment is typically made within one working day of placing the redemption request. With mutual funds going online, individual investors with small sums can look at Liquid funds as an effective short-term investment option over their savings bank account.