Now investors have an additional reason to consider overnight funds

Overnight funds primarily invest in debt instruments with a residual maturity of one day. In simpler terms, the entire asset holding of the funds can be classified as “cash and cash equivalents”.

The key point is that such schemes are restricted from investing in any “risky” debt instruments to ensure the risk of default in the bond portfolio to be virtually nil.

Primarily, overnight funds earn through interest payment on their debt holdings. The securities are bought within a day to mature and benefit from the overnight price difference.

Returns received from overnight funds are directly related to the rise and fall in overnight lending and borrowing rates. When interest rates rise, it tightens the market liquidity, increasing the overnight rates and, thus, benefitting investors.

Even with the decrease in interest rates, investors still gain as they earn interest on idle money.

Under the instant access facility (IAF) initiative, investors will receive redemption proceeds in their bank account within a few hours, as opposed to the next day in case of normal redemption transactions. It will thus add to investor convenience.

Earlier, only liquid funds were made eligible for this facility. Investors will also be allowed to withdraw up to 90 per cent of the value of their units, subject to a cap of Rs 50,000 per day per scheme.

Moreover, as per circular dated July 30, 2021, Sebi has also allowed unclaimed redemption money and dividends to be invested in separate plans created in overnight schemes from December 1, in addition to earlier allowed liquid schemes and money market mutual fund schemes floated by mutual funds.

Investments in overnight funds
The fund category has been witnessing healthy investor interest in line with the objective of generating regular returns.

Advantages for the investor
As overnight funds are relatively unaffected by the market volatility, and as they invest in overnight securities only, the risk of making any capital losses is virtually nil.

The returns on overnight funds should be seen in the light of idle cash which does not provide any appreciation of value.

These are low-cost debt funds as they are not managed actively. This is why the overnight fund proves ideal for investors who are looking for a short investment horizon of a week or less.

Who should invest in these funds?
Traditionally, it was the institutional investor category that parked their funds into debt schemes, primarily for corporate purposes. However, in recent years, individual small investors too have chosen various kinds of debt schemes, including overnight schemes for parking their funds, with a purpose. Investors are using overnight schemes for making STP (Systematic Transfer Plan) into chosen equity funds.

Finally, those who are risk-averse and are looking to park their money for a very short term or for fulfilling the need of financial emergency are also taking the benefit of overnight schemes. With greater liquidity due to IAF along with reasonable returns, investors stand to gain from overnight schemes.

Taxation on overnight funds
In overnight funds, investors earn dividend income and capital gains. As per current tax laws, gains on the sale of units held for a shorter period for upto 3 years are added to an individual investors’ income and taxed at the marginal tax rate.

Likewise, gains from selling of units for more than three years are subject to long-term capital gain (LTCG) at the rate of 20 per cent after indexation (adjusting purchase price according to inflation).

Summary
Investing in overnight funds is fruitful, if the investment horizon is ideally a week or at best a fortnight. Also, importantly, overnight funds need to be used for parking money for a certain specific objective for a specified period. It may not be wise to shift the entire corpus to this category, given higher inflation. Investors must carefully pick up the schemes with a consistent track record and in line with their financial goals.

The author is Chief Executive, L&T Mutual Fund. Views expressed are personal.