Overnight Funds – What, When and Why to Invest in them

Overnight Funds are the least risky mutual funds. They are less risky than the Liquid Mutual Funds as well.

This is a type of debt fund with practically no interest rate fluctuation risk and credit rating risk and low credit default risk. Overnight Funds are like investing in your savings bank account with slightly higher returns. This money can be part of your emergency fund or just money that you want to keep aside for a while for whatever reason without worrying about gains.

What is an overnight Mutual Fund work?

It is a debt mutual fund that invests in bonds that mature in one day! So at the start of each business day, the entire AUM would be in cash, overnight bonds would be purchased, they will mature the next business day, the fund manager would take the cash and buy more overnight bonds and so on. So each the NAV increase just a little bit due to the interest income.

Interest Rate Risk – If a bond matures the next business day, its price will not be affected if RBI changes the (overnight) interest rate. Next day, your bonds mature and you will buy new overnight bonds at the new rate.

Credit Rating Risk – If the credit rating of the bond issuer changes, the bond price will not be affected as your bond will mature the next day.

Default Risk –  There is a risk only if the issuer of the bond absconds with your money or refuses to pay up: credit default risk.  To manage this risk, there is collateral from the bond issuer. However, not fully covered, it still offers some protection for this risk.

In what product do these funds invest in?

Overnight funds invest in debt instruments with one day to maturity. When the bonds mature, the fund reinvests the proceeds in the next set of one-day instruments. The risk from default or fall in value within a day is negligible. Typically, the funds invest in collateralized borrowing and lending agreements (CBLO), a short term borrowing facility backed by securities of the central government through which mutual funds lend to banks and others, and reverse repos. Both of these are protected from credit risk since they are backed by collateral securities. The schemes may also invest in money market instruments such as treasury bills, certificates of deposit and commercial papers with residual maturity of not more than a day. If the interest rate for the day is high, the returns from overnight funds are up and vice-versa, with no impact on the value of the securities.

Who should choose overnight funds?

Anyone who wants to park money with the least amount of risk without worrying about returns.

A business owner who has a current account and thus, does not earn any interest on the cash lying in his/her account can invest in overnight funds to make some gains on their working capital.

Liquid Funds or Overnight Funds

Liquid funds holding securities with the highest credit quality will still earn better returns than overnight funds given that they hold securities with 25-30 days to maturity, while overnight funds cater to the need for a liquid investment with negligible risk for investors looking to park their funds for very short periods of time (a day maybe). 

Many liquid funds allow investors to withdraw up to 50,000 instantly, and offers useful online features, looking for a steady short-term ride or parking funds for your emergency needs – liquid funds are still preferable.

However, recently SEBI has announced certain changes where they have said there will be an exit load associated with liquid funds. However, the exact % and the impact of it is not yet announced. Once that is there, the investor will have to take an overall call based on the returns and the cost of investment.

Wealth Cafe Actionable – If you can manage a little risk, invest in overnight funds every Friday and withdraw the same on Monday earning gains over the weekend.

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