Overnight Mutual Funds

Overnight funds are among the lowest risk categories of debt mutual funds, designed for investors seeking a place to park surplus money for extremely short durations. These schemes invest in securities that mature within a single business day, allowing the portfolio to reset daily and keeping interest rate sensitivity relatively low.

While the return potential of such funds is market-linked and may vary based on short-term market conditions, their structure offers high liquidity. For investors or institutions aiming to manage day-to-day cash flows, overnight funds may serve as a suitable short-term allocation option. This article tells you more about overnight funds, their benefits, risks and taxation rules, to help you make an informed decision.

Table of contents

• What are overnight funds?
• How do overnight funds work?
• Benefits of investing in overnight mutual funds
• Taxation rules of overnight funds
• Who should invest in overnight funds?
• How to invest in overnight funds

What are overnight 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.

How do overnight funds work?

The working mechanism of an overnight fund is a simple, rolling daily cycle:

• One-day maturity: The fund manager invests chiefly in overnight securities. These instruments, such as Reverse Repos or Tri-Party Repos (TREPS), have a residual maturity of only one day.
• Daily reset: At the start of each business day, the underlying securities in the fund's portfolio mature, and the principal amount, along with the potential returns generated from the securities, flow back into the fund.
• Reinvestment cycle: The fund manager then typically reinvests the matured proceeds into a fresh set of overnight securities that will mature the following business day. This daily reinvestment cycle keeps the portfolio continuously refreshed and maintains its very short duration profile.

Benefits of investing in overnight mutual funds

Relatively stable and potentially better returns: Ab 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 Investors can use a compound interest calculator to compare the return potential of the two avenues.

*Returns on fixed deposits/savings accounts are fixed, however, returns on mutual funds are subject to market risks.

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. Overnight funds, with their relatively low-risk profile, may appeal to conservative investors. To estimate how regular investments could grow, a SIP calculator can be a helpful tool for planning.

Taxation rules of overnight funds

Any gains arising from the redemption of units of an overnight fund will be added to the investor’s total income and taxed according to the investor’s applicable income tax slab rate. The benefit of indexation is no longer applicable.

Who should invest in overnight funds?

Overnight funds may be suitable for the following individuals:

Investors with a very short-term horizon: These funds may be suitable for parking cash for a brief duration.

Individuals requiring high liquidity for surplus cash: If you have funds that are temporarily idle, such as money awaiting an immediate large expense, overnight funds may be suitable.

Investors with a low risk appetite: Due to the one-day maturity of the underlying instruments, overnight funds carry minimal interest rate risk and relatively low credit risk compared to other debt categories.

Users of systematic transfer plans (STPs): These funds may serve as the source fund for an STP. An investor can place a lumpsum into an overnight fund and set up a plan to systematically transfer units to an equity or hybrid fund over time.

How to invest in overnight funds

The process of investing in an overnight fund can be done through two main channels, online or offline, and requires the following initial steps:

Complete your Know Your Customer (KYC) process: Ensure you are KYC validated.

Select the suitable fund and plan: Research different overnight schemes offered by asset management companies (AMCs).

Decide on the investment method: Choose the mode of investment based on your requirement:

Lumpsum: A single, one-time investment, which is the most common method for parking short-term surplus cash.

Systematic investment plan (SIP): While less common for overnight funds, you may set up regular, fixed investments.

Place the order: Execute the transaction, either:

• Online: Via the AMC’s website, an RTA platform, or a registered aggregator platform.
• Offline: By submitting a physical application form and cheque/transfer details at the AMC’s official point of acceptance.

You may invest independently, via the Direct Plan, or take the help of a mutual fund distributor who will make the investment on your behalf via the Regular Plan.

Conclusion

Overnight funds may be a suitable tool for managing short-term liquidity needs. Since they invest chiefly in securities that mature within one business day, these funds have very high level of liquidity and relatively low volatility. These schemes are generally suitable for investors, both individuals and institutions, who have a low risk appetite or a very short-term horizon (ranging from a single day to a few weeks).

FAQs:

What is an overnight mutual fund?

An overnight fund is a debt mutual fund that invests in securities with a one-day maturity. The portfolio is refreshed daily, keeping interest rate exposure minimal. It may be suitable for parking money for very short periods, but returns depend on market conditions and are not assured.

Are overnight funds safe?

No mutual fund category is entirely risk-free. Overnight funds are typically classified as low risk, because they invest in instruments having a maturity of one business day, making their interest rate sensitivity relatively low. However, returns are still market-linked and not guaranteed. Investors may still review credit quality, risks, and suitability before choosing them for short-term parking of surplus money.

Who is a suitable investor for overnight funds?

Overnight funds may be suitable for investors looking to park surplus money for extremely short periods while keeping interest rate sensitivity relatively low. They are not risk-free, so reviewing the fund’s portfolio, personal liquidity needs, and risk tolerance remains important before allocating money to such short-term debt schemes.

What are the benefits of investing in overnight funds?

Overnight funds offer very short maturity exposure, relatively low interest rate sensitivity, and quick liquidity. They may suit investors seeking a temporary parking option for surplus money. However, returns are variable and market-linked, so reviewing risks and suitability is important before choosing them for short-term allocation.

How are overnight funds taxed in India?

Overnight funds follow the same taxation pattern as all debt-oriented schemes. Capital gains are taxed as per the investor’s slab rate, regardless of the holding period.

Can overnight funds earn better returns than savings accounts?

Overnight fund returns may sometimes offer higher potential returns than savings accounts, but they are market-linked and not assured. Savings accounts offer fixed rates set by banks, while returns from overnight funds are not guaranteed and may fluctuate based on short-term market conditions. Investors may compare liquidity needs, risk tolerance, and suitability rather than expect consistently higher performance.

Returns on fixed deposits/savings accounts are fixed, however, returns on mutual funds are subject to market risks.

What is the difference between overnight funds and liquid funds?

Overnight funds invest in one-day maturity instruments, keeping interest rate sensitivity relatively low. Liquid funds invest in debt instruments with maturities of up to 91 days, creating slightly interest rate risk.

How to redeem or exit from overnight funds?

Overnight funds usually allow redemption on any business day, with proceeds credited according to the fund’s cutoff and settlement timelines. Some AMCs also offer instant redemption on overnight funds. There are generally no exit loads. Investors may check scheme documents and verify operational timelines with the AMC or distributor before placing redemption requests for clarity and planning.

Is there a lock-in period in overnight funds?

Overnight funds typically do not have a lock-in period, allowing investors to redeem on any business day. However, operational cutoffs and settlement timelines may apply. Reviewing scheme documents helps ensure clarity on access to funds and any conditions associated with transactions.

Are the returns of overnight funds fixed or variable?

Returns from overnight funds are variable and depend on short-term money market conditions. Since the portfolio resets daily, outcomes fluctuate and are not guaranteed. Investors may use them for short-term parking while understanding that returns may change and are subject to prevailing market conditions.