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Home / Glossary / Debt Funds / Overnight Funds

Introduction

Overnight funds are a type of debt mutual fund that invests in securities with a maturity of one day. These funds aim to provide investors with high liquidity and low-risk investment options, making them ideal for short-term parking of surplus funds. The primary objective of overnight funds is to offer returns that are marginally higher than a regular savings account while maintaining capital safety and liquidity.

Key Features of Overnight Funds

  1. High Liquidity: Overnight funds invest in securities that mature in one day, providing investors with the flexibility to withdraw their investments quickly without any exit load.
  2. Low-Risk: Due to the ultra-short maturity period of the underlying securities, overnight funds carry minimal interest rate risk and credit risk.
  3. Stable Returns: While the returns from overnight funds are not very high, they are relatively stable and predictable compared to other debt funds.
  4. Suitable for Short-Term Investments: These funds are ideal for investors looking to park their surplus cash for a very short duration, such as a few days or weeks.
  5. No Lock-In Period: Investors can redeem their units at any time without any penalties, providing complete flexibility.

How do Overnight Funds Work?

Overnight funds are a type of debt mutual fund that invests in securities with a one-day maturity. These funds offer high liquidity and minimal risk, making them the safest form of debt mutual funds and ideal for very short-term investments.

1. Investment Strategy

  • One-Day Maturity Securities: Overnight funds invest exclusively in overnight securities, which mature in just one business day. These include instruments such as overnight reverse repos and tri-party repos, where the fund lends money to a borrower for a single night and gets it back with interest the next day.
  • Daily Rollover: The fund reinvests the proceeds from maturing securities into new overnight instruments the next day, ensuring the portfolio always consists of one-day maturity instruments.

2. Risk Profile

  • Low Credit Risk: Since the securities in overnight funds mature in just one day, the credit risk is virtually eliminated. The short maturity period ensures that the likelihood of default is extremely low.
  • No Interest Rate Risk: The one-day duration also means that overnight funds are not affected by changes in interest rates, making their net asset value (NAV) very stable.

3. Liquidity

  • High Liquidity: Overnight funds are highly liquid, allowing investors to redeem their investments almost instantly. The redemption proceeds are typically credited to the investor’s account on the next business day, making these funds ideal for parking idle cash temporarily.
  • Daily NAV Calculation: The NAV of overnight funds is calculated daily, providing transparency and up-to-date information on the value of the investment.

4. Returns

  • Stable Returns: Overnight funds offer stable but modest returns, reflecting the low-risk nature of the underlying investments. While the returns are generally lower compared to other types of debt funds, they are consistent and predictable.
  • Interest Income: The primary source of returns in overnight funds is the interest earned from the overnight lending of funds, which is reinvested daily.

5. Taxation

  • Capital Gains Tax: The taxation on gains from overnight funds depends on the holding period. If you hold them for more than three years, you treat the gains as long-term capital gains (LTCG) and tax them at 20% with indexation benefits. For a holding period of less than three years, you treat the gains as short-term capital gains (STCG) and tax them according to your income tax slab.
  • Dividend Distribution Tax (DDT): If investors choose the dividend option, the dividends are subject to dividend distribution tax, which is deducted by the fund before payout.

6. Suitability

  • Short-Term Parking: Overnight funds are ideal for investors looking to park their money for very short durations, ranging from a day to a few weeks. They are particularly useful for corporate treasuries, businesses, and individual investors who need to manage cash flow or temporarily invest surplus funds.
  • Safety and Liquidity: The combination of safety, liquidity, and stable returns makes overnight funds a preferred choice for risk-averse investors seeking a safe place to park their cash.

You may also want to know Ultra Short Term Funds

Benefits of Investing in Overnight Funds

Overnight funds are among the safest and most liquid investment options available in the debt mutual fund category. Here are the key benefits:

1. High Liquidity

One of the primary advantages of overnight funds is their high liquidity. Investors can redeem their investments quickly, with the funds typically being credited to their account on the next business day. This makes overnight funds ideal for parking surplus cash that might be needed on short notice.

2. Minimal Risk

Since overnight funds invest in securities that mature within one day, they carry minimal credit risk and no interest rate risk. The extremely short maturity period ensures that the risk of default is almost nonexistent, and the NAV is stable, even during periods of market volatility.

3. Stable Returns

While the returns from overnight funds are modest, they are stable and predictable. The interest earned from overnight lending is reinvested daily, providing a steady source of income with little to no fluctuation in returns.

4. Ideal for Short-Term Parking

For investors looking to park their money for a very short duration, overnight funds offer an excellent solution. They are especially useful for corporate treasuries, businesses, or individuals needing to manage cash flow or temporarily invest surplus funds.

5. Transparency

The NAV of overnight funds is calculated and disclosed daily, offering investors full transparency on the value of their investments. This daily calculation ensures that investors are always aware of the current worth of their investment.

6. No Lock-In Period

Overnight funds do not have a lock-in period, allowing investors to redeem their investments at any time without worrying about exit loads or penalties. This flexibility makes them suitable for meeting unforeseen expenses or emergencies.

You may also want to know Money Market Funds

Risks Associated with Overnight Funds

While overnight funds are considered one of the safest investment options, they are not entirely without risks. Here are the potential risks associated with investing in overnight funds:

1. Lower Returns

The primary risk of overnight funds is the relatively low return on investment. Since these funds invest in very short-term instruments, the returns are generally lower compared to other debt funds or equity investments. This makes them less suitable for investors seeking higher returns.

2. Reinvestment Risk

Although overnight funds are not directly exposed to interest rate risk, they are subject to reinvestment risk. In a declining interest rate environment, the returns from these funds may decrease as the interest earned on overnight securities drops, leading to lower yields over time.

3. Inflation Risk

The returns from overnight funds may not always keep pace with inflation. While they are safer than most other investments, the modest returns may result in the erosion of purchasing power over time, particularly in high-inflation environments.

4. Tax Implications

Gains from overnight funds are subject to short-term capital gains tax if held for less than three years, which could be taxed according to the investor’s income tax slab. This can reduce the effective return for investors in higher tax brackets, making post-tax returns less attractive.

5. Limited Growth Potential

Due to the nature of the underlying assets, overnight fund do not offer the potential for significant capital appreciation. They are designed for stability and liquidity rather than growth, which may not align with the goals of long-term investors seeking higher returns.

Popular Overnight Funds in India

  1. HDFC Overnight Fund: Known for its consistent performance and low expense ratio, this fund invests in high-quality overnight securities.
  2. SBI Overnight Fund: Managed by SBI Mutual Fund, this fund aims to provide high liquidity with low risk and stable returns.
  3. BSE Overnight Money Fund: A fund that focuses on maximizing returns while ensuring the liquidity and safety of the principal.
  4. ICICI Prudential Overnight Fund: Offers a good mix of liquidity and returns, making it suitable for short-term investments.
  5. HSBC Overnight Fund: In an overnight fund like HSBC, the focus is on capital preservation and liquidity, investing exclusively in high-quality, short-duration instruments to deliver stable returns with minimal risk, making it ideal for managing short-term cash flow needs.

How to Choose the Best Overnight Fund?

Selecting the right overnight fund is crucial for maximizing the benefits of this low-risk investment option while aligning it with your financial goals. Here’s a detailed guide on how to choose the best overnight fund:

1. Fund’s Track Record

Although overnight funds generally offer similar returns, it’s important to review the historical performance of the fund. Look at the fund’s consistency in delivering stable returns over different market cycles. Funds with a proven track record of steady performance and minimal volatility are usually a safer bet.

2. Expense Ratio

The expense ratio is a key factor when choosing an overnight fund. It represents the annual fee charged by the fund to manage your investment. Since overnight fund typically offer modest returns, even a slight difference in the expense ratio can impact your net returns. Opt for a fund with a lower expense ratio to ensure you keep more of your returns.

3. Credit Quality of the Portfolio

Review the credit quality of the securities in the fund’s portfolio. The best overnight funds invest in high-quality, short-term instruments with minimal credit risk, such as government securities or top-rated corporate debt. Ensuring high credit quality minimizes the risk of default and provides greater safety for your investment.

4. Liquidity Management

Consider the fund’s liquidity management practices, which ensure that you can redeem your investment quickly and without hassle. Check the fund’s track record for honoring redemption requests promptly and whether there have been any instances of delayed payments. A fund with good liquidity management will be able to meet redemptions smoothly, even during periods of market stress.

5. Asset Under Management (AUM)

The size of the fund, or its Assets Under Management (AUM), can impact its performance. While a larger fund may indicate investor trust, an excessively large AUM could limit the fund manager’s flexibility in quickly buying or selling securities. On the other hand, very small funds may face challenges in diversifying their portfolios. Aim for a fund with a balanced AUM that aligns with your needs.

6. Reputation of the Fund House

The reputation and track record of the fund house managing the overnight fund are important considerations. Opt for funds managed by well-established and reputable fund houses known for their prudent risk management practices. This ensures that your investment is in safe hands, especially during volatile market conditions.

7. Yield to Maturity (YTM)

The Yield to Maturity (YTM) indicates your potential returns from the fund, assuming you hold all securities until maturity. While YTM is not a guaranteed return, it provides a useful benchmark for comparing different overnight funds. Look for a fund with a competitive YTM, but also consider the risk factors associated with achieving those yields.

8. Exit Load and Minimum Investment

While most overnight funds do not have an exit load (a fee for early redemption), it’s still worth confirming. Additionally, check the minimum investment requirement to ensure that it aligns with your available capital. A fund with no exit load and a low minimum investment threshold offers greater flexibility.

9. Tax Efficiency

Consider the tax implications of the overnight fund, particularly how it fits within your broader tax strategy. Since gains from overnight funds are subject to short-term capital gains tax, understanding the post-tax returns is essential. Funds that offer slightly better post-tax returns might be more suitable, depending on your tax bracket.

Taxation of Overnight Funds

Gains from overnight fund are taxed based on the holding period:

  • Short-term Capital Gains (STCG): If units are held for less than three years, the gains are added to the investor’s income and taxed according to their income tax slab.
  • Long-term Capital Gains (LTCG): If units are held for more than three years, the gains are taxed at 20% with indexation benefits.

Conclusion

Overnight fund are an excellent option for investors looking to park their surplus funds for a very short duration with minimal risk. They offer high liquidity, safety, and stable returns, making them suitable for managing short-term cash requirements. By carefully selecting funds based on performance, expense ratio, credit quality, and the fund manager’s expertise, investors can optimize their returns while managing risks effectively.

Frequently Asked Questions

What are overnight funds?

Overnight funds are debt mutual funds that invest in securities maturing within one day, providing high liquidity and low-risk investment options.

How do overnight funds differ from liquid funds?

Overnight funds invest in securities with a maturity of one day, while liquid funds invest in securities maturing within 91 days, making overnight funds even more liquid.

Are overnight funds suitable for emergency funds?

Yes, due to their high liquidity and low risk, overnight funds can be an excellent option for parking emergency funds.

How are overnight funds taxed?

Gains from overnight funds are taxed as short-term capital gains if held for less than three years and long-term capital gains if held for more than three years, with respective tax treatments.

What is the average return on overnight funds?

Returns vary based on market conditions and the fund’s portfolio but are generally higher than savings accounts and competitive with short-term fixed deposits.

Can I lose money in overnight funds?

While the risk is low, there is still a possibility of loss due to credit risk or market fluctuations.

How often can I redeem from overnight funds?

Redemptions are typically processed within one business day, making them highly liquid.

What is the minimum investment amount for overnight funds?

The minimum investment amount varies by fund, but it is typically low, making these funds accessible to most investors.

Who should invest in overnight funds?

To invest in overnight mutual funds an investor should be looking for better returns than savings accounts with high liquidity and low risk should consider overnight funds.

What factors should I consider when choosing an overnight fund?

Consider the fund’s performance, expense ratio, credit quality of the portfolio, the fund manager’s track record, and your investment horizon.

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