Returns of liquid funds are meant only for the short term and don't help investors create wealth over the long term, as equity funds do.
Liquid funds have offered an average return of 7.28 per cent over the past year.
October saw these funds attract significant inflows of Rs 83,863 crore, following an outflow of Rs 72,666 crore in September.
The recent launch of Shriram Liquid Fund's new fund offer has also sparked fresh investor interest in these funds.
"Liquid funds are an ideal place to park money for short-term requirements. They normally provide higher returns compared to savings or current accounts, as the money is invested in short-term instruments that yield higher returns," says Rahul Pal, chief investment officer, fixed income, Mahindra Manulife Mutual Fund.
"Also, since the instruments are short-term, these schemes generally have a good credit profile," Pal adds.
These funds invest in money market instruments maturing in up to 91 days, including treasury bills, commercial papers issued by corporates, and certificates of deposits issued by banks.
Focus on safety
Liquid funds are designed to prioritise liquidity and capital safety over high returns.
Most schemes invest in top-quality papers, making them suitable for parking short-term funds like sale proceeds from property and other investments.
"Liquid funds are excellent short-term parking instruments while one waits to deploy money for the longer term," says Sandeep Bagla, chief executive officer, TRUST Mutual Fund.
Impact of interest rates
Liquid fund returns are likely to be muted in the future compared to last year.
"Interest rates are expected to come down over the next six months. Hence, liquid fund returns might be lower in the coming year than last year," says Ravi Kumar T V, Gaining Ground Investment's founder.
Bagla concurs. "Liquid fund returns are expected to trend lower over the next few quarters. We expect repo rates to be reduced by 75-100 basis points (bps) over the next 18 months, starting February 2025."
"Hence, liquid fund returns may reduce gradually from current levels in line with the cuts," says Bagla.
Not suited for long term
For medium-to-long-term goals, investors should consider funds with matching durations.
"Returns of liquid funds are meant only for the short term and don't help investors create wealth over the long term, as equity funds do," says Kumar.
Investors could incur some opportunity costs by investing in them.
"If longer-term yields move lower, longer-maturity bond funds could generate handsome returns for investors. To that extent, staying invested in liquid funds could result in some opportunity cost," says Bagla.
Ideal for conservative investors
Most liquid funds take minimal credit and interest-rate risk. Hence, even the most conservative investors can consider them.
"Everyone can look to invest in liquid funds for short-term deployment of funds. They can also be excellent conduits for systematic investment plans (SIPs) into equity-oriented funds," says Pal.
When selecting a liquid fund, choose one with large assets under management (AUM), a diversified high-quality portfolio, and a low expense ratio.
"While most liquid funds invest in good-quality securities (AAA-rated), one should also consider the fund's size and yield to maturity when choosing one," says Kumar.
Other short-term options
Investors seeking short-term investment opportunities have several other choices.
"For short-term deployment, there are other funds like overnight funds, ultra-short-term, low-duration, and money market funds," says Bagla.
"The returns from these funds could be higher than liquid funds, but the volatility of returns could be higher as well, depending on system liquidity and short-term rates," adds Bagla.
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Feature Presentation: Ashish Narsale/Rediff.com
