Does the headline look surprising? It may, given the fact that liquid funds are supposedly the most stable among all mutual fund categories. However, given the negative returns in a few liquid funds over the past couple of months due to IL&FS fiasco, the question is relevant: is there anything even safer than liquid funds? Well yes, there is.
SEBI has permitted a new fund category called ‘overnight fund’ in October 2017 implemented from June 2018. This is new because earlier hardly one or two AMCs had a fund of this description. Now that the category has been defined, many AMCs are gradually coming out with this fund. After the IL&FS episode, AMCs are likely to offer this fund to investors who want complete safety of their principal at the cost of marginally lower returns.
Now, let us look at what the fund is. As per SEBI definition, an overnight fund is characterized by ‘Investment in overnight securities having maturity of 1 day’ and the type of scheme is ‘An open ended debt scheme investing in overnight securities’. The SEBI definition ends there.
Even though it is not stated there in so many words, what it means is investment in CBLO. CBLO, which stands for Collateralized Borrowing and Lending Obligations is similar to the inter-bank call money market. Simply put, CBLO is a money market instrument where financial institutions secure short-term loans to meet their transaction requirements. Financial institution raise eligible securities against the secured collateral that include central government securities such as treasury bills with at least six months left to the maturity date.
We started by saying, this category is safer than liquid funds. How is that? Let’s see what the risks in debt investments are: (a) interest rate risk, also known as market risk or volatility risk (b) credit risk and (c) counterparty risk. In CBLO, though there are tenures longer than one day, the most popular segment is overnight i.e. one day. In any case, for overnight funds, deployment will be for one day only. Since the deployment is for one day only, there is no mark-to-market related risk as once a contract is entered, the return is defined. There may be a re-investment rate issue i.e. deployment rate next day may be little lower, but there is no risk to principal on account of mark-to-market.
Coming to credit risk, it is managed by Clearing Corporation of India (CCIL), the central counterparty to all trades and offers high quality collateral securities for the transactions.
It is to be noted here that for overnight deployment or borrowing of funds, CCIL has dismantled CBLO of the nomenclature that existed earlier and has replaced it by a system called TREPS, which stands for Tri-Party Repo. Since there are three parties involved i.e. the two regular counterparties for the transaction and CCIL as the central counterpart, the change of nomenclature was required. In this context, “Triparty Repo” has the same meaning as assigned to it under Triparty Repo (Reserve Bank) Directions, 2017.
Returns from overnight funds will be little lower than liquid funds. However, at the cost of a little lower returns, it makes sense for investors who are seeking principal protection. The only thing investors need to take care of is the special dispensations granted to liquid funds e.g. previous day’s NAV, NAVs declared on Sundays and so on.