How to select liquid funds?
If we look at the assets under management (AUM) of liquid funds, then we would realise that they are the most heavily invested mutual funds. As on April 2020, its AUM was Rs 4.05 lakh crore and inflows was around Rs 68,848 crore (Source: AMFI). If we look at its AUM contribution, then liquid funds contribute around 17 per cent of the total AUM of mutual funds.
Why we see such heavy investments in liquid funds?
Institutions are the biggest contributors towards liquid funds. Now, you might think why institutions? As you know, businesses need to have a current account for doing any business transactions. These accounts offer zero interest rates on their balances. When retail investors have their money parked in savings bank account, they usually, receive interest rate of 3.5 per cent to 4 per cent but there are few banks that even offer interest rates up to seven per cent with some terms and conditions. However, these institutions earn nothing.
Therefore, they are usually looking for investment avenue that offers:
1. High liquidity
2. High Safety
Hence, liquid funds as well as overnight funds comply with the above two requirements. They both have lower interest rate and credit risk. Also, they have no entry and exit restrictions until Securities and Exchange Board of India (SEBI) imposed restrictions on redeeming liquid funds. Liquid funds can be redeemed without any exit load after seventh day of investment.
How to select liquid funds?
Investment in liquid funds is made for two basic reasons, i.e. safety of capital and liquidity. Therefore, to pick suitable liquid funds, the criteria should fulfil the above-mentioned two things. Let’s see things that you should consider while selecting liquid funds.
AUM
It is usually advised that one should never chase funds with larger AUM. However, the story is quite opposite in case of liquid funds. While investing in liquid funds, consider those funds that have large AUM. Liquid funds invest in instruments that have maximum maturity period i.e. up to 90 days. If many investors start redeeming from the fund, the fund manager will have to withdraw from the securities prematurely. This will even have an adverse impact on the returns of the funds. Hence, due to this, it is better to go with those liquid funds that have large AUM. They can handle redemption pressures with ease, as compared to small AUM. As a thumb rule, consider investing in liquid funds with AUM greater than Rs 20,000 crore.
Credit quality and portfolio concentration
As we had previously discussed that, safety of capital is one of the topmost priorities for investing in liquid funds. So, while investing in liquid funds, it is crucial to assess the credit quality along with portfolio concentration. It is no-brainer that the maximum exposure of the assets should be towards AAA rated papers and sovereign rated instruments. Further, to avoid the dependency on single paper or different papers of single company or group, it is important to check how concentrated its portfolio is.
Low expense ratio
Finally, you also need to check liquid funds that have low expense ratio. Lower the expense ratio, better it is. However, while doing so, do not take decisions based on a single criterion. Rather, invest while considering all the above listed criteria.