Overnight Funds

Overnight funds are open-ended debt mutual fund schemes that invest in securities with a maturity of just one day. This means, the securities in the portfolio mature every day and the fund manager uses the proceeds to buy new securities for the portfolio maturing the very next day. 

Since the securities in these funds mature the next day, these funds are not exposed to the kind of interest rate risk or default risk like the rest of the debt funds, but this low-risk profile also implies they offer low returns. As of February 29, 2024, this fund category has assets under management (AUM) of Rs 67,724.65 crore with 35 schemes with the oldest being 27 years old, and the category ranked 8th in the list of open-ended debt funds according to the Association of Mutual Funds in India (AMFI).

Source: AMFI website as of February 29, 2024

While you should identify your risk profile and plan your financial goals before investing in overnight funds, here are some situations where they may fit in:

Alternative to Bank Current and Savings Account

As of February 27, 2024, the annual return on overnight funds is between 6.51-7.3%. On the other hand, interest rates offered by large banks on current and savings accounts range between 0-4%. So overnight funds have the potential to generate higher returns than current and savings accounts. It is important to note that overnight funds’ returns are market-linked and not fixed.

Source: Valueresearch, SBI, HDFC Bank, ICICI Bank, BOB websites as of February 19, 2024

Note: While overnight funds are good alternatives to current and savings accounts, they are not insured like them. Up to Rs. 5 lakh per bank account are insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC).

Ultra-Conservative Investors

Those who prioritise security above all else and need a very low risk investment option. Overnight funds are subject to minimal credit and interest rate risk due to their extremely short-term nature.

Investors Needing High Liquidity

Individuals or businesses who need to park money temporarily and require the ability to access their funds quickly, often the next business day.

Emergency Fund Parking

Individuals who maintain an emergency fund for unexpected expenses may find overnight funds attractive. The funds provide liquidity and a modest return, making them suitable for emergency fund parking.

Dividend Taxation

These funds pay out dividends when you invest in their IDCW (Income Distribution Cum Withdrawal) option. Dividends are taxed at your marginal income tax rate, and TDS (Tax Deducted at Source) at 10% applies to dividends received more than Rs 5,000 per AMC per financial year.

Safety and Low Risk

Overnight funds primarily invest in very short-term debt instruments with a maturity of one day. This short duration minimises interest rate risk and credit risk, making them relatively safe compared to funds with longer durations.

High Liquidity

Most overnight funds allow you to redeem your investment the next business day, offering unparalleled liquidity. This makes them perfect for parking money you'll need to access very soon.

Stable Returns

While returns from overnight funds are not guaranteed, they are generally stable and predictable over the short term. The funds aim to provide returns slightly higher than traditional savings accounts while maintaining a low level of risk.

Suitability for Short-Term Goals

Overnight funds are suitable for investors with short-term financial goals or those who need to park their funds for a brief period. They provide an alternative to traditional savings accounts with potentially higher returns.

Portfolio Diversification

Overnight funds primarily invest in very short-term debt instruments like Government Securities (G-Secs), Treasury Bills (T-Bills), Collateralized Borrowing and Lending Obligations (CBLOs), Certificates of Deposit (CDs), Commercial Papers (CPs), etc. with a maturity of one day. This short duration minimises interest rate risk and credit risk, making them relatively safe compared to funds with longer durations.

Limited Returns

Overnight funds prioritise capital preservation over high returns. They invest in ultra-short-term instruments that offer modest interest rates. They shouldn't be viewed as a primary tool for building wealth over the long term.

Interest Rate Sensitivity

While less exposed to interest rate fluctuations compared to longer-term debt funds, overnight fund returns can still be affected by changes in short-term interest rates. If interest rates decline, the income generated by overnight funds may also decrease.

Expense Ratios

Like other mutual funds, overnight funds have expense ratios that cover the fund's operating costs. While these expenses are relatively low, they still reduce the overall returns for investors.

Inflation Risk

The modest returns from overnight funds might not always outpace inflation. This means the real purchasing power of your money could erode if inflation rises.

Overnight funds offer an attractive option for Indian investors seeking a very safe and highly liquid place to park their funds, particularly if they need quick access. Their ultra-short-term investments are minimally affected by market volatility. However, keep in mind that they prioritise safety over high returns. If your primary goal is long-term wealth creation, other debt fund categories or equity-focused investments might be more suitable. Before investing, consider your individual financial objectives and risk tolerance to ensure overnight funds align with your needs.