Worried about risk in debt mutual funds? Park your money in overnight mutual funds

Published: May 12, 2018 at 9:58 am

Last Updated on December 25, 2023 at 7:54 pm

A fixed deposit is one of the simplest instruments to understand. However, make the FD tradeable mid duration then all sorts of complications will arise. You will lose money if you try and sell when interests increase or if the bank suffers financial trouble and drops in credit ratings. It is no secret that debt mutual funds are complicated but risk-averse investors can consider parking their money in overnight mutual funds. This is a type of debt fund with practically no interest rate fluctuation risk and credit rating risk and low credit default risk.

As a student, I love debt mutual funds because of the above-mentioned complexities and regular readers may be aware that there is exclusive category available with as many as 47 posts. The essential posts have been combined into a Free E-book: A Beginner’s Guide To Investing in Debt Mutual FundsEven those who do not know what a debt mutual fund is can use the book to start investing. Note: All of us will need debt mutual funds when we retire even if we do not want to or have no need for them now. So it is important to learn more. Why?  Because you can smartly  reduce Tax with Partial Mutual Fund Withdrawals( Examples + Calculator)

Before this post, I had created a poll at FB group Asan Ideas for Wealth: “Will you park money (not invest) in a liquid mutual fund that has practically no interest rate fluctuation risk and pretty low credit default risk? This means you will only get a little more return than SB account. 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. This is with reg to my next post. Curious how many will be interested in such an option. Not implying that this is a good or the best option. Just curious about risk-reward sentiment here.”

Yes: 329 votes and No: 129 votes. Most people who disagreed believed that a high-interest SB account or a flex-deposit SB+FD account is better than an overnight mutual fund. I agree that bank accounts will work for small sums. As long as you get 10K interest income free from an SB account and that too at around 6%, why would you look elsewhere?

Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!
🔥Enjoy massive discounts on our robo-advisory tool & courses! 🔥

Overnight mutual funds can be useful for those with a reasonably large corpus. Maybe an emergency fund, maybe part of your medical expenses fund. Maybe you want to time the market. The point is that those who have made partial withdrawals from a debt fund (now equity fund) will attest that the taxation is low even if you have to pay as per slab as there is no concept of interest (see above post).

Please do note that the risk in an overnight mutual fund is lower than a typical liquid fund. So this means the return will be a bit low. Of course, star rating guys will compare apples with tomatoes because they are red in colour and offer lower stars to overnight mutual funds. The stupidity behind that is obvious. I have already discussed this point and how to spot overnight mutual funds in this post: How to Choose a Liquid Mutual Fund. With all that out of the way, let get to it.

What is an overnight mutual fund?

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. Does that crazy to you? Probably, but it is not without benefits.

If a bond matures the next business day, it 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.If the credit rating of the bond issuer changes, the bond price will not be affected as your bond will mature the next day. You are in trouble only if the issuer absconds with your money or refuses to pay up: credit default risk. To handle this, the agency that organises the transaction get collateral (security) from the bond issuer. So that default risk is also taken care off (not 100%, but more than reasonably).

overnight mutual funds invest in CBLOs - bonds that mature the next business day

Why would an issuer offer an overnight loan? Because the government or large corporations may need excess cash for a day. So they borrow. Next day, they check again. If they have excess cash, they will lend to other companies. Else they will borrow again. Naturally, the interest rate would be pretty low. But then again if you want safety and peaceful sleep, you got to a pay a price.

Please note that prior to SEBI categorization rules, overnight funds were called cash funds, or cash management funds etc. So this is a sub-category of liquid funds.

Where do overnight mutual funds invest?

Their most popular choice of bond is a Collateralized Borrowing and Lending Obligation (CBLO). This is run by the clearing corporation of India – CCIL The corporation seeks collateral from bond issuers to mitigate risks as the “repayment of borrowing under CBLO Segment is guaranteed by CCIL” (see) The collateral itself is a short-term government bond. Since the value of the collateral will fluctuate on a daily basis due to market forces, CCIL will demand an amount proportional to the fall in value from the issuer to cover their losses. Members of CCIL-CBLO segment also have an obligation to lend. Even within that one day, some bonds will have a put and call option. That is, the bond buyer can ask the issuer to pay back mid-term (put option) or the bond issuer can payback on their own mid-term (call option). All this is, of course, a simplistic depiction of what happens. So experts kindly bear with me.

Just to reiterate, bond price due to interest rate movements and credit rating changes are practically non-existent in an overnight bond. Default risk is minimised due to a great extent due to the presence of collateral, a guarantee by the clearing corporation (because of the collateral) and the fact that the tenure is just one business day. The major risk in an overnight fund is reinvestment risk. If rates keep falling then the fund will have lower and lower return. Of course, this risk is present in any accrual based fund. You can expect 5-6% from this fund as per current rate scenario.

Overnight mutual funds can also invest in reverse repos – a money market instrument where you sell the bond back to the issuer at a higher price or any other bond with overnight maturity. After reading this, I would bet that many of the 329 voters who said “yes they would choose such a fund” will change their mind! You might be thinking why go into so much trouble. Well it is a sm

Examples of overnight mutual funds

1 HDFC Cash Management Fund – Call Plan  – new name: HDFC Overnight Fund. It will now be a pure overnight fund investing mainly in CBLOs.

2 L&T Cash fund – now will be an overnight fund.

3 UTI G-Sec Fund will now become UTI overnight fund.

4 SBI Magnum InstaCash Fund – Liquid Floater will now become SBI Overnight Fund

Please note that there are differences in the investment strategies of each fund. While the objective would be to predominantly invest in overnight securities some of them can use derivatives  (debt arbitrage), invest in uncollateralized corporate overnight bonds etc. So please read the scheme documents linked above if you are interested.

Who should choose overnight funds?

Anyone who wants to park money with the least amount of risk without worrying about returns. Anyone who will not be needing a big lump sum in one shot and likely to make partial withdrawals.

So what you think? Will you consider such liquid funds? Or will you stick to bank deposits or take a bit more risk with ultra-short term funds or use only arbitrage to minimize tax out go?

Do share this article with your friends using the buttons below.

🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 5000+ users!
Use our Robo-advisory Tool for a start-to-finish financial plan! More than 1,000 investors and advisors use this!
New Tool! => Track your mutual funds and stock investments with this Google Sheet!
We also publish monthly equity mutual funds, debt and hybrid mutual funds, index funds and ETF screeners and momentum, low-volatility stock screeners.
Follow Freefincal on Google News
Follow Freefincal on Google News
Subscribe to the freefincal Youtube Channel. Subscribe button courtesy: Vecteezy.
Subscribe to the freefincal Youtube Channel.
Follow freefincal on WhatsApp Channel
Follow freefincal on WhatsApp
Podcast: Let's Get RICH With PATTU! Every single Indian CAN grow their wealth! 
Listen to the Lets Get Rich with Pattu Podcast
Listen to the Let's Get Rich with Pattu Podcast
You can watch podcast episodes on the OfSpin Media Friends YouTube Channel.
Lets Get RICH With PATTU podcast on YouTube
Let's Get RICH With PATTU podcast on YouTube.
🔥Now Watch Let's Get Rich With Pattu தமிழில் (in Tamil)! 🔥
  • Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
  • Have a question? Subscribe to our newsletter using the form below.
  • Hit 'reply' to any email from us! We do not offer personalized investment advice. We can write a detailed article without mentioning your name if you have a generic question.

Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!

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 ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), 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 promoting unbiased, commission-free investment advice.
Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! More than 3,000 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 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 700 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 and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!   
Our new book for kids: “Chinchu Gets a Superpower!” is now available!
Both boy and girl version covers of Chinchu gets a superpower
Both the boy and girl-version covers of "Chinchu Gets a superpower".
Most investor problems can be traced to a lack of informed decision-making. We 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, what would it be if we had to groom one ability in our children that is key not only to money management and investing but to any aspect of life? 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 parents plan for it, as well as teaching 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 is for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Do you want to check if the market is overvalued or undervalued? Use our market valuation tool (it will work with any index!), or get the Tactical Buy/Sell timing tool!
We publish monthly mutual fund screeners and momentum, low-volatility stock screeners.
About freefincal & its content policy. Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. 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 with credible and knowledgeable sources before publication. Freefincal does not publish paid articles, promotions, PR, satire or opinions without data. All opinions will 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 and seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.
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 into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, and 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 300 (instant download)