Investors use the category of mutual fund schemes called liquid funds (also known as money market funds) for short-term parking, as these funds are most stable in returns. There is another category of funds known as ultra short-term bond funds (earlier known as liquid plus), which are managed in a manner similar to liquid funds. It is necessary that investors are aware of both types of funds and their respective advantages that will aide in making informed decisions.
Liquid funds are those that are defined as money market funds in the offer document and invest in money market instruments of residual maturity up to 91 days. What sets liquid funds apart in terms of lowest volatility in returns among all categories of funds is that there is no mark-to market (MTM) of the portfolio on a daily basis unless there is a trade in the secondary market in the underlying security (or securities). Practically there is no trade in money-market instruments and valuation of daily NAV happens on an accrual basis i.e., by adding the coupon accrued for the day without any mark-to-market impact.
Ultra short-term bond funds (USTBs) are defined as debt funds in the offer document and the fund manager is free to take securities of maturity longer than 91 days, but there is no compulsion to do the same. Valuation of daily NAV happens as per the valuation matrix provided by the rating agencies, hence there could be a mark-to-market impact. However, the component of securities with residual maturity more than 91 days (for which the valuation matrix is published) is maintained on the lower side, so that the volatility in returns is limited.
Returns in USTBs are marginally higher than liquids by virtue of the marginally higher portfolio maturity. Normally, the longer the maturity of the instrument, the higher is the yield on that instrument (time value of money). USTBs have the liberty to purchase securities with maturity of more than 91 days and on an average, the portfolio maturity is longer than liquids funds. This leads to a higher accrual rate on the portfolio of USTBs. The volatility of returns in USTBs is marginally higher than liquids funds due to the small MTM component.
OPERATIONAL ASPECTS:
In liquid funds, purchase is T-1 i.e., cleared funds are given to the AMC by the cut-off time of 2 pm and availing of previous day's NAV. Redemption is T+1 i.e., the redemption request is placed within the cut-off time of 3 pm and the proceeds are received the next day.
In USTBs, purchase is on a T+0 basis i.e. that day's NAV would be applicable. If the amount is more than . 1 crore, clear funds have to be given to the AMC by the cut-off time of 3 pm, otherwise the NAV of the day on which clear funds are being given will be applicable. Redemption is T+1 for USTBs as well. For both fund categories the application should be submitted and time stamped at the AMCs'/RTA's office within the cut-off time.
TAXATION DIFFERENCES:
While dividends are tax-free in the hands of the investor, there is a dividend distribution tax (DDT) that is deducted by the AMC on behalf of the investor and passed on to the government.
The rate of DDT in case of liquid funds is 25% (plus surcharge/cess). From June 1, 2011, the DDT rate for corporate investors will go up to 30%.
In case of USTBs, there are two rates of DDT: for individual investors, it is 12.5% (plus surcharge/cess) and for corporate investors the rate is 20% (plus surcharge/cess). From June 1, the DDT rate for corporate investors will go up to 30%.
The advantages of liquid funds are that they provide stable returns and T-1 purchase. Another advantage is the declaration of NAVs on Sundays/holidays as well, which means redemption request put in on Friday (within the cut-off time) for proceeds on Monday would be at Sunday's NAV.
In USTBs, this redemption will take place at Friday's NAV (since there is no NAV on holidays), which means no accrual income for two days. The advantages of USTB funds are marginally higher returns than liquid funds and tax efficiency over liquid funds i.e., lower DDT rate for individuals. For a horizon of more than two weeks, investors can avail of the relatively higher returns and tax efficiency of USTBs and for a short horizon of a few days, liquid funds are safer. Both the fund categories can be used for systematic investments into equity funds.
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Also, know how to buy mutual funds online:
1) DSP BlackRock Mutual Funds:
http://prajnacapital.blogspot.com/2011/05/buying-dsp-blackrock-mutual-funds.html
2) Reliance Mutual Funds:
http://prajnacapital.blogspot.com/2011/06/buying-reliance-mutual-funds-online.html
3) Birla Sunlife Mutual Funds:
http://prajnacapital.blogspot.com/2011/06/buying-birla-sunlife-mutual-funds.html
4) UTI Mutual Funds:
http://prajnacapital.blogspot.com/2011/06/buying-uti-mutual-funds-online.html
5) SBI Mutual Funds:
http://prajnacapital.blogspot.com/2011/06/buying-sbi-mutual-funds-online.html
6) Edelweiss Mutual Funds:
http://prajnacapital.blogspot.com/2011/06/buying-edelweiss-mutual-funds-online.html
7) IDFC Mutual Funds:
http://prajnacapital.blogspot.com/2011/06/buying-idfc-mutual-funds-online.html
