Overnight Funds

What are Overnight Funds?

Overnight funds are the most recent addition to India's available mutual fund (MF) categories. These open-ended funds invest in debt securities, Reverse Repos, and Collateralized Borrowing and Lending Obligation (CBLOs) with one-day (overnight) maturity.

Although retail investors can invest in overnight funds, these MFs are preferred by big institutional investors and corporate houses. Overnight funds returns are higher than current bank accounts and are less riskier than equity funds since they have minimal default and credit risks. The biggest advantage of overnight funds is that they are 100% liquid and can be bought and sold on the same day.

Who Should Invest in Overnight Funds?

Overnight funds are the best investment instrument for high net worth investors and big financial institutions. These funds provide them with higher returns than conventional bank current deposits. Here is a lay down on the types of investors who prefer to invest in overnight mutual funds:

  • Investors with a super-low investment horizon can invest in overnight funds. These funds can be sold on the next day or any day you want. 
  • If you are looking for a better investment option than a current account, overnight funds will suit you well. Corporate establishments and large financial institutions invest their idle or surplus cash in these funds for a few days until they need it for working capital requirements.
  • Investors looking to reap the benefits of STP or Systematic Transfer Plan can invest in overnight funds. Investors can transfer their money from an overnight fund to equity or pure debt funds using the STP facility.
  • Although retail investors can also invest in some of the best overnight funds, they prefer liquid funds. Liquid funds are like overnight funds, but they usually provide higher returns than overnight funds. Also, the credit and interest rate risks of liquid and overnight funds are similar.
  • Any investor willing to understand the fundamentals of the debt market before investing more money. 
  • Any investor willing to get better post-tax returns than bank fixed deposits.
  • Any investor looking for a 100% liquid investment option with no exit load or fee for withdrawing prematurely.

Taxability of Overnight Funds 

The best overnight funds are more tax-efficient than many other investment options. Overnight fund returns may attract two types of taxes – Short-Term Capital Gains (STCG) tax and Long-Term Capital Gains (LTCG) tax. Since these funds are classified as ‘Debt Funds,’ the STCG applies on withdrawals made before three years while the LTCG applies on withdrawals made after three years. 

Regarding STCG, any profits made by the investor are taxed according to the investor’s tax slab. So, if your income falls in the 30% tax bracket, you will need to pay 30% tax on the profits from overnight funds. However, LTCG is taxed at a flat rate of 20% after indexation. Indexation refers to adjusting the returns against inflation during the period. Also, if you receive any dividend from the scheme, it will be taxed as per your existing tax slab.   

Hence, before investing, consider the returns’ taxability to maximise profits.

Risks Involved With Overnight Funds

Overnight funds are mostly known for their benefits, as the holding period is generally no more than a day. But, despite such fascinating benefits, there are also some downsides of investing in overnight funds: 

  • Sensitivity to Interest Rate – Although not commonly seen, overnight funds are quite sensitive to interest rates. For instance, if you invest at 10 AM today and the RBI decides to reduce the rates at 3 PM, your scheme returns may decrease considerably. Conversely, if the RBI decides to increase the rates, you may benefit from the sudden jump in the fund value. 
  • Returns are Not Too High – Overnight funds are not good instruments for long-term investment. They typically provide a little higher returns than bank savings or current accounts. So, liquid funds will be a good choice if you want to earn higher returns and invest in a fund closely resembling overnight funds.   
  • Credit Risks Cannot Be Ruled Out – While this scenario is highly unlikely and has never happened before, all debt funds are subject to credit risks. If the issuer of the underlying asset defaults on the payment on instrument maturity, the investor may lose a part of their investment.   
  • Lack of Control – Overnight funds are generally managed by fund managers who oversee the portfolio selection process. Hence, although you are an investor, you cannot influence the debt instrument selection in any way. 

Advantages of Overnight Mutual Funds

The following are the top benefits of investing in overnight funds:

  • Safe Returns – Since the investment term of overnight funds is much lesser than conventional mutual funds, the risks of capital loss are minimal. 
  • Idle Fund Utilisation – While the minimum term of a bank fixed deposit is seven (7) days, overnight funds mature after one day. Hence, investors with huge capital prefer investing in these funds to grow their capital before needing the money. 
  • Less Volatility – Traditional debt funds are more exposed to credit or interest rate risks than overnight funds. Since an overnight fund’s portfolio changes every day, it safeguards investors from a sudden jump or fall in interest rates and also credit and liquidity risks. 

100% Liquid – Mutual fund houses do not levy any entry or exit load on overnight funds. Hence, the investment cost of overnight funds is zero. Moreover, you can withdraw your money any time you want.