Overnight Mutual Funds also have risks! What investors need to know

The risk of loss in an overnight mutual fund is the lowest among all mutual funds. However, that is only one type of risk! What investors should know before parking cash in these funds!

Published on / By M. Pattabiraman Twitter: @pattufreefincal / 1 Comment

Published: April 3, 2020 at 10:43 am

Last Updated on December 29, 2021

An overnight mutual fund invests in bonds of the shortest maturity: one day. This means its portfolio is essentially cash and changes each day! While the loss of capital in this category is the lowest among all mutual funds, there are other risks that investors have to appreciate.

Debt mutual funds suffer from two primary types of risk: credit risk and interest rate risk. The interest rate risk has two components: (A) Higher the tenure of the bonds held by a fund, more the NAV will fluctuate due to market supply and demand changes.

In extreme situations, even liquid funds can react to demand and supply: Why Liquid funds and money market funds also fell in the last few days. (B) The second type of interest rate is known as reinvestment risk.

Build a complete financial plan with our Robo Advisory Tool. More than 1000 investors and financial advisors use it!
Get free money management solutions delivered to your mailbox! Subscribe to get posts via email! (Subscribers get exclusive discounts!)

New Tool! => Track your mutual funds and stocks investments with this Google Sheet!

This is much less appreciated as it does not lead to an actual loss of capital. Instead, It leads to a lower return when fresh bonds have a lower interest rate. All short-term debt funds such as overnight funds, liquid funds, money market funds and ultra short-term funds suffer from this risk, It is a risk because the fund would fail to meet the return expectation of the investor.

Both the equity and bond market suffered from investor pull out last month. RBI had to step in to buy bonds to arrest the fall in yields. The lack of demand in the cash market was compounded by the lowering of the reverse repo rates by as much as 0.9%! This is done to remove from liquidity (money supply) in the system.

This means that financial institutions will find it significantly less rewarding to park money with RBI. This means that yields of short-term bonds will be significantly lower. Both these factors have affected all money market funds including liquid funds and overnight funds.

This is where reinvestment risk comes into play. Since overnight funds will be the first to immediately buy the new bonds with a lower interest rate, their NAV will be affected the most. The NAV will not fall, but the rate at which it moves up will significantly change. If you remember high school math, the slope of the NAV vs time chart will fall. When the slope falls, the returns will fall.

This is shown for Kotak Overnight fund in the image above. Going forward, the returns from all overnight funds should head close to that of an SB account.  Investors who use these funds to park cash without return expectations will however not be affected.

The table below shows how the 7-day absolute return of overnight funds for two different weeks have suddenly changed.

Table shows the abrupt change in weekly returns of overnight funds
Table shows the abrupt change in weekly returns of overnight funds

Investors who shifted money from liquid funds in fear to overnight funds will have to pay the price with guaranteed lower returns.

What should retail investors holding overnight funds do? Nothing other than appreciating reinvestment risk! Stay put but do not expect much returns in the coming months. Also do not make hasty decisions like shifting money into overnight funds (from other debt funds) or pulling out of overnight funds. We can run from investment risk but cannot hide. There is always a price to pay.

Do share if you found this useful
Explore the site! Search among our 2000+ articles for information and insight!

About The Author

Pattabiraman editor freefincalDr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over nine years of experience publishing news analysis, research and financial product development. Connect with him via Twitter or Linkedin or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation for promoting unbiased, commission-free investment advice.
Use our Robo-advisory Excel Template for a start-to-finish financial plan! Now with a new demo video! ⇐ More than 1000 investors and advisors use this!
Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! ⇐ More than 2800 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter what the market condition is!! Watch the first lecture for free!  One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course!  Increase your income by getting people to pay for your skills! ⇐ More than 675 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts you and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!   
My new book for kids: “Chinchu gets a superpower!” is now available!
Both boy and girl version covers of Chinchu gets a superpower
Both boy and girl version covers of Chinchu gets a superpower.
Most investor problems can be traced to a lack of informed decision making. We have all made bad decisions and money mistakes when we started earning and spent years undoing these mistakes. Why should our children go through the same pain? What is this book about? As parents, if we had to groom one ability in our children that is key not only to money management and investing but for any aspect of life, what would it be? My answer: Sound Decision Making. So in this book, we meet Chinchu, who is about to turn 10. What he wants for his birthday and how his parent’s plan for it and teach him several key ideas of decision making and money management is the narrative. What readers say!
Feedback from a young reader after reading Chinchu gets a Superpower (small version)
Feedback from a young reader after reading Chinchu gets a Superpower!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. - Arun.
Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Did you know? We have more than 1000+ videos on YouTube to explore! Join our YouTube Community!
Want to check if the market is overvalued or undervalued? Use our market valuation tool (will work with any index!), or you buy the new Tactical Buy/Sell timing tool!
We publish mutual fund screeners and momentum, low volatility stock screeners .every month.
About freefincal & its content policy Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on developments in mutual funds, stocks, investing, retirement and personal finance. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified from credible and knowledgeable sources before publication. Freefincal does not publish any paid articles, promotions, PR, satire or opinions without data. All opinions presented will only be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions, seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now. It is also available in Kindle format.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is an in-depth dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step. Get the pdf for Rs 199 (instant download)
Free android apps