#BQMutualFundShow: Benefits Of Liquid Funds Over Bank Fixed Deposits
Liquid funds don’t just allow investors to put in money for very short durations but also have the added advantage of higher returns compared to savings deposits, said Suresh Soni and Kumaresh Ramakrishnan on BloombergQuint’s weekly series, The Mutual Fund Show.
“Compared to a bank’s saving deposit, you would actually get 200-250 basis point higher in a liquid fund where you can pull out it in 15 days,” Ramakrishnan explained.
Here are edited excerpts from the interview.
What are the options available to investors in the debt funds category?
Kumaresh Ramakrishnan: Debt funds offer you a plethora of choices across the board. Broadly you can classify them on the basis of open-ended debt funds and close-ended debt funds. Open-ended debt funds tend to be the bigger of the two in terms of the total assets that are managed. Within open-ended funds, we have funds starting from very short-end products like liquid and ultra-short-term funds which are largely meant for very short-term deployment or short-term surpluses which people could have. Liquid funds can be as short as one day, going all the way to 10 days or a month or so.
For example, if I received my salary today and I have few payments on EMIs during the month or suppose my EMI comes at the end of two weeks from now, normally, I do not have too many choices. My money could go to a savings account where I would be earning 3.5 percent. But if I want to deploy that money for 15 days’ time, then a liquid fund is an excellent choice. Compared to a bank’s saving deposit, you would actually get 200-250 basis point higher in a liquid fund where you can pull out it in 15 days.
Over the last one year, liquid funds have delivered 6-6.5 percent returns on an average. Currently, savings deposit rates in banks are 3.5-4.5 percent. So, you make about 200-250 basis point comfortably from what you could normally make if you would just put that money in a bank.
In liquid funds, the taxation would be the same as the interest that you earn from a savings account?
Suresh Soni: Largely I would say that they are marginally lower, but they are very close to what you would have to pay in a bank fixed deposit. The benefits that you get are in terms of higher returns in very short periods of time. You can put money in a liquid fund for as short a period as 1-5 days. If you need to put money in a bank fixed deposit, it can’t be anything less than 7 days. So, if you want to put money for 10 days, you have to open a short-term bank FD which doesn’t give you more than 4.5 percent. So, it is a very good choice. More than the taxation, there is flexibility in terms of returns and ready liquidity.
Between ultra-short-term funds and the short-term funds, what is the differentiation and what kind of investors should opt for such funds?
Suresh Soni: The ultra-short-term would be fairly close to a liquid fund. If your time horizon is anything up to 1-6 months, let’s say you are looking to pay your home installment and construction link payment is 3 months from now and you have to set aside money for that, then you can probably save in ultra-short-term funds. So, you would use it for a 1-6 month window. A short mutual fund term tends to be a vehicle where you will go from about 6 months to 3 years.
Do the returns differ dramatically from liquid to short-term to ultra-short-term funds?
Suresh Soni: If you look at the product categories they are essentially differentiated based on the time horizon, and the time horizon is also reflected in the time horizon of the securities they hold.
Liquidity products run a short-term portfolio which is 90 days. Ultra-short-term goes to 6 months or thereabout and short maturity funds start from one year and go up to 3-4 years. Therefore, they are suitable for the investors who are broadly looking at slightly longer and longer term.
In terms of returns, they keep going up as you keep the money for a slightly longer period of time. So, liquidity products would start at about 6-7 percent as the recent experience show while the short majority funds go up to 8 percent over the last year to about three years. Mutual funds returns are market-linked, and they will fluctuate along with the market, but this is the last three years’ experience.
Why would the returns fluctuate so much?
Kumaresh Ramakrishnan: The reason that the prices of debt mutual funds will change is because of the change in the market prices of the underlying bonds that these funds hold. For example, equity prices change on a daily basis which leads to change in the value of the equity. Similarly, in the case of the bond funds or the debt funds, you have changes in the bond prices. Bond prices generally do not change as much as equity prices. In the short term, equity tends to be quite volatile. Bond prices also change. But the change in bond prices is because of interest rate expectations in the short term.
Liquid funds do not buy very long securities. Unlike in a bond fund which may buy 3-5-year security. Security prices can fluctuate depending upon how the interest rate expectation changes. As actively managed funds, it is normally our responsibility how we manage those funds to ensure that we mitigate the impact of these fluctuations on a daily basis.
Most of the returns range from 7-10 percent as far as debt returns are concerned. You reckon that’s the real expectation or would you differ?
Suresh Soni: 7-10 percent returns is what most of the funds have delivered for the last three years. Today interest rates are probably a little lower than what they were earlier. Remember, in the overall context of asset allocation, in the mutual fund industry we get talked about a lot in the context of equity funds. But 60 percent of our assets are held in debt funds. It’s a pity that at this point in time, it’s only the corporate investors who put bulk of the money into debt mutual funds. I would think that it is a very good opportunity for retail investors, individual, small business enterprises to look at these funds because there is a solution for every need that you have. We have seen a lot of corporates use debt funds and increasingly we are finding HNIs using it. The mutual fund industry is about 40 percent in equity and 60 percent in debt funds.