Overnight Mutual Funds

An overnight fund is a type of debt mutual fund that invests in securities that mature in a single business day. In simple terms, an overnight fund is a mutual fund that invests in overnight securities. These securities have a maturity period of just one business day, making them distinct from other types of mutual funds.

The core purpose of an overnight mutual fund is to offer potentially reasonable returns that are in line with its relatively low-risk profile and high liquidity. The pooled money from an overnight fund is primarily channeled toward overnight securities. This makes these plans a preferred choice for institutions that want to park surplus funds for just one day or for investors with spare cash aiming for returns that are marginally superior to those of their current account.

Understanding the features of an overnight fund is instrumental for investors with specific short-term financial goals. Its blend of benefits, especially in terms of low risk and high liquidity, makes it an attractive option for both institutional entities and individual investors with idle cash resources.

Table of contents

• What are overnight funds?
• How do overnight funds work?
• Objectives of overnight funds
• Overnight funds example
• Benefits of investing in overnight mutual funds
• Who should invest in overnight funds?
• Taxation rules of overnight funds
• Risk-return profiles of overnight funds
• Optimising risk in overnight funds
• Evaluating returns in overnight funds

What are overnight funds?

Overnight funds are a type of open-ended debt mutual fund that primarily invest in securities with a residual maturity of one day. This structure makes overnight funds less sensitive to interest rate fluctuations and default risks typically associated with other debt funds. Due to their conservative approach, returns from overnight funds may be modest compared to other debt mutual funds.

How do overnight funds work?

Overnight funds invest in debt securities with a one-day maturity, in line with SEBI regulations. Once these securities mature, the proceeds are reinvested in new one-day securities, creating a continuous rollover cycle.

This daily reinvestment maintains the high liquidity and low-risk profile of the fund. Investors can redeem their investments at any time, making overnight funds a suitable option for parking short-term surplus funds safely.

Objectives of overnight funds

Overnight funds may suit the following objectives:

1. Short-term parking – May serve as a low-risk avenue to park surplus funds with better return potential than savings accounts.

2. Low risk – Focus on relative stability of capital invested and minimal exposure to defaults.

3. High liquidity – Investments can be redeemed anytime and there are typically no exit loads.

Overnight funds example

Imagine you have ₹1 lakh to invest in an overnight fund with a NAV of ₹1,000 per unit.

• Initial investment: ₹1,00,000
• Units purchased: 100 (₹1,00,000 ÷ ₹1,000)
• Overnight growth: Assuming a daily return of approximately 0.016% (equivalent to about 6% annualised), the next day your investment value becomes ₹1,00,016.
• Investment value: ₹1,00,016

Example for illustrative purposes only.

Benefits of investing in overnight mutual funds

Relatively stable and potentially better returns: A clear advantage of an overnight mutual fund is its capability to provide potentially stable returns. While modest, the return potential is often marginally better than what a regular savings account might yield. However, the risk associated with overnight funds is comparatively higher than savings accounts.

• Suitable for short-term goals: One of the benefits of overnight mutual funds as an investment avenue is in the case of short-term objectives. Be it for parking extra cash or for addressing immediate monetary needs, the structure of overnight funds is tailored to cater such goals efficiently.
• Liquidity: Overnight funds make their investments in securities that mature within a day, which is why the liquidity factor of these funds is very high. This ensures that if the investor has a sudden requirement for funds, these can be liquidated quickly and easily.
• Easy access to funds: In today’s digital age, ease of transactions is an important factor for investors to consider. Investors can park their money in overnight funds via both online and offline modes. Additionally, redeeming these investments is a straightforward and hassle-free process. With the Insta redemption facility, investors can redeem Rs. 50,000 or 90% of the invested amount, whichever is lesser, instantly.
• Relatively low risk: The securities in which an overnight fund invests mature within a day. This reduces the interest rate risk associated with them. The relatively low-risk profile makes overnight funds a preferred choice for conservative investors.

Who should invest in overnight funds?

Overnight funds may be suitable for investors who have a short-term cash surplus that is not required for immediate use. They may also be considered by those looking for a liquid investment option that allows easy access to funds without locking in capital.

These funds are generally recommended for conservative investors seeking a relatively stable place to park funds temporarily while maintaining flexibility.

Taxation rules of overnight funds

Overnight funds are classified and taxed as debt mutual funds.

For investments made after April 1, 2023, all gains from these funds are considered short-term capital gains and are taxed according to the investor’s applicable income tax slab rate.

This means that returns from overnight funds are added to the investor’s taxable income and taxed accordingly. Investors should consider the tax implications while planning their investments in overnight funds.

Risk-return profiles of overnight funds

Overnight funds are structured to prioritise mitigation of risk to principal while ensuring high liquidity. Therefore, while these funds are comparatively less vulnerable to instability in the broader economy, they offer a lower return potential compared to other types of mutual funds, especially equity-oriented plans.

Hence, overnight funds carry a low risk/low return potential profile making them suitable for conservative investors who seek a stable alternative to savings accounts for parking surplus funds for short periods.

However, overnight funds are still theoretically impacted by the following types of risk:

• Interest rate risk: Changes to the central interest rate affect bond performance and yields and can in turn affect the overnight funds that invest in them. However, since the maturity period is just one day, the potential impact of interest rate changes on overnight funds is minimal compared to that on longer duration funds.
• Credit risk: Since the maturity of overnight funds is extremely short, there is negligible risk that the issuers of the securities held by the fund may default on their obligations.

Optimising risk in overnight funds

When assessing risk in overnight funds, investors should the credit quality. The credit quality of the issuers of the underlying securities in the fund's portfolio is an important factor to consider when analysing risk in overnight funds. Investors should look for funds that invest in highly rated securities with a low risk of default.

Evaluating returns in overnight funds

When evaluating returns in overnight funds, investors should consider several factors. These include:

• Benchmark comparison: Investors should compare the fund's returns with a relevant benchmark, such as the overnight indexed swap (OIS) rate or the repo rate. This will help them determine whether the fund is generating above-average returns.
• Expense ratio: The expense ratio is an important factor to consider when evaluating returns in overnight funds. Investors should look for funds with a low expense ratio, as this can impact the overall returns generated by the fund. However, generally most overnight funds have expense ratios on the lower side.

Conclusion

Overnight debt mutual funds may offer a potentially lower-risk option for parking short-term surplus funds. They provide liquidity and the potential for reasonable returns. Understanding the risk-return profile, minimum investment requirements, and interest rate trends may help investors determine if these funds are suitable for their short-term financial objectives.

FAQs

What is the overnight fund meaning?

Overnight funds may be mutual funds that invest in very short-term debt instruments with a maturity of one day.

Are overnight funds risky?

They may carry relatively lower risk compared with longer-duration debt funds, but returns are market-linked.

Who should invest in these funds?

Investors seeking short-term parking of surplus funds with potentially stable returns may consider them.

What is the minimum investment amount for overnight funds?

The minimum investment may vary by fund house, often starting from Rs. 1,000.

What are the benefits of investing in overnight mutual funds?

They may offer liquidity, potentially stable returns, and may be suitable for short-term parking of funds.

How long is an overnight fund?

The fund invests in instruments with a one-day maturity, but your investment may remain until you redeem.

What is the rate of interest of an overnight fund?

Overnight funds don’t offer interest; they offer potential returns which depend on prevailing interest rates and the credit quality of instruments in the portfolio.