Overnight Funds

Overnight funds are open-ended debt funds focusing on overnight securities or assets maturing within one day. Each business day begins with the Asset Under Management (AUM) held in cash, which the fund manager promptly invests in next-day maturing bonds.
EXPLORE FUNDS
What is Overnight Fund
EXPLORE FUNDS
3 mins read
10-January-2025

Overnight funds are open-ended debt funds that invest in overnight securities or assets with a residual maturity of one day. At the start of each business day, the Asset Under Management (AUM) is held in cash; subsequently, the fund manager invests in overnight bonds that mature on the next business day. Fund managers tend to utilise the cash amount to purchase more bonds overnight, and the cycle continues.

This article will delve deeper into overnight funds meaning, overnight funds advantages, overnight funds taxation and many more in detail.

What are overnight funds?

Overnight funds belong to the category of open-ended debt funds that primarily invest in assets or securities with a residual maturity of just one day. In this unique investment strategy, the fund manager ensures that the portfolio consists of securities that mature daily. As these securities mature, the fund manager utilises the proceeds to acquire new securities with a one-day maturity, creating a continuous cycle.

The distinctive feature of overnight funds lies in their immunity to interest rate risk and default risk, common in other types of debt funds, as the securities mature the very next day. However, the conservative risk profile translates to comparatively lower returns. This category of debt funds emerged in 2018 as part of SEBI's mutual fund reclassification initiative.

How do overnight funds work?

Overnight funds invest in diverse debt securities, each with a maturity of just one day, adhering to SEBI regulations that restrict investments in instruments with a maturity period exceeding a single day. Consequently, the fund's portfolio undergoes daily changes as underlying securities mature, making room for fresh ones. Essentially, the fund manager replaces overnight-maturing debt instruments with new ones daily, resulting in a consistent turnover. The Assets Under Management (AUM) sees incremental growth due to interest payments from these securities.

Objectives of overnight funds

Overnight funds cater to investors seeking to maximise returns on their idle cash for short periods. These funds offer three key advantages:

  • Short-term parking: They provide a safe and liquid avenue to invest your extra cash, ensuring easy access whenever needed.
  • Low risk: By investing in securities maturing the next day, there's minimal risk of default, making them a conservative option within debt funds.
  • High liquidity: Overnight funds invest in assets that can be readily converted to cash within a day by redeeming units from the fund house. This ensures easy access to your money while still generating returns.

Overnight funds example

Imagine you have ₹2 lakhs to invest and choose an overnight fund with a current Net Asset Value (NAV) of ₹1000 per unit.

  • Initial investment: You would receive 200 units of the fund (₹2 lakhs / ₹1000 per unit).
  • Overnight growth: Suppose the next day, the fund's NAV increases to ₹1001.
  • Investment value: Your investment would now be worth ₹2,00,200 (200 units * ₹1001).

This simple example illustrates how overnight funds can potentially generate small but relatively quick returns.

Advantages of investing in overnight funds

Listed below are some advantages of investing in overnight funds:

  • Low risk: Overnight funds are considered to be very low-risk investments as the underlying securities have low default risk.
  • Liquidity: Overnight funds are highly liquid investments. This means that investors can easily redeem their units at any time.
  • Moderate Returns: While returns are modest, they tend to be higher than traditional savings accounts.
  • Investment Flexibility: In overnight funds, investors have the freedom to deposit and withdraw their funds at their discretion. Once the initial deposit is made, you have the option to reinvest your funds daily or make withdrawals as needed. Investors who choose to reinvest their funds increase their potential for long-term profitability.

Who should invest in overnight funds?

Overnight funds are a good investment option for investors who have the following characteristics:

  • They have short-term cash surpluses that they do not need for immediate use.
  • They are looking for a relatively safe and liquid investment option.
  • They are willing to accept a lower level of returns in exchange for safety and liquidity.
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Overnight fund taxability

The returns from overnight funds are taxed same as debt mutual funds. Short-term capital gains tax is applicable if the units are redeemed within three years of purchase, which is equivalent to investor’s tax slab. If the units are redeemed after three years, the returns are taxed as long-term capital gains, which is taxed at a flat rate of 20% after indexation.

If the investor chooses Income distribution cum capital withdrawal (Since overnight funds are meant for liquidity, con) option, then the dividend income will be subject to tax.

Risks involved with overnight funds

Overnight funds offer several advantages due to their very short holding period, typically lasting less than a day. However, despite these benefits, there are some drawbacks to consider when investing in overnight funds:

  • Interest Rate Sensitivity – Overnight funds can be sensitive to changes in interest rates, though this is not always evident. For example, if you invest in the morning and the RBI lowers interest rates in the afternoon, your returns might decrease significantly. Conversely, an increase in rates could lead to a sudden rise in the fund's value.
  • Modest Returns – Overnight funds are not ideal for long-term investments, as they generally provide returns slightly higher than those of bank savings or current accounts. If you're looking for better returns, you might consider liquid funds, which offer higher yields while still providing similar liquidity to overnight funds.
  • Credit Risk – While rare, overnight funds are not entirely free from credit risk. In the unlikely event that the issuer of the underlying assets defaults on its obligations, there could be a loss of part of your investment.
  • Limited Control – Investors in overnight funds have no say in the selection of the debt instruments within the fund. The portfolio is managed by  fund managers, leaving you with no influence over the investment choices made.

How to find the best overnight mutual fund

Finding the best overnight mutual fund involves evaluating several key factors to ensure it meets your investment needs. Here’s a concise guide on how to choose the right one:

  • Understand the objective: Overnight mutual funds are designed for short-term investments, typically with a holding period of less than a day. They aim to provide high liquidity and safety, often investing in very short-term debt instruments. Your objective should align with this purpose, such as parking surplus cash or managing temporary liquidity needs.
  • Check performance: While past performance isn’t a guarantee of future returns, reviewing a fund’s historical performance can offer insights into its consistency and reliability. Compare the performance of various overnight funds over different periods to identify those that have consistently delivered returns close to the benchmark.
  • Evaluate expense ratios: The expense ratio is the annual fee expressed as a percentage of the fund’s average assets under management. Lower expense ratios can enhance your net returns. Look for funds with competitive expense ratios, but also consider other factors like fund size and management quality.
  • Review fund manager expertise: The experience and track record of the fund manager are crucial.  A seasoned fund manager can navigate interest rate fluctuations and credit risks effectively. Research the manager’s background and their approach to managing overnight funds.
  • Assess credit quality: Overnight funds typically invest in high-quality, short-term debt instruments. Check the fund’s credit quality and ensure it adheres to a conservative credit policy to minimize risk.
  • Compare liquidity: Since overnight funds are meant for liquidity, confirm that the fund maintains high liquidity levels. This ensures you can quickly access your money without significant delays or penalties.

By carefully considering these factors, you can select an overnight mutual fund that aligns with your investment goals,  risk tolerance, and liquidity needs.

How to invest in overnight funds?

Here’s a step-by-step guide to invest in mutual funds on the Bajaj Finserv platform:

Step 1: Verify your details for KYC Compliance

  • Tap on ‘Invest Now’ to get started.
  • Enter your PAN, Name, Date of Birth (as mentioned in your PAN card).
  • Agree to the Mutual Funds Terms of Use.

Step 2: Email Verification

  • Once you pass KYC compliance, move on to verify your email.

Step 3: Update your Bank Details

  • Enter your Account Holder Name, Account Number, IFSC code, and Account Type.
  • We will deposit Rs. 1 to confirm your account.

Step 4: Enter Basic Details

  • Gender
  • Occupation
  • Pin Code
  • Address

Step 5: Upload your Signature

  • Upload your signature to be used for your account opening process.

Step 6: Complete the Nominee & FATCA details for your portfolio

And you’re done!

You can now select your choice of funds, choose the investment mode (SIP/ Lumpsum) and payment mode (Net banking, UPI, NEFT/ RTGS).

List of overnight mutual funds

How Overnight Funds Help with Your Investment Portfolio Diversification

Overnight Funds, or overnight mutual funds, are a valuable addition to any investment portfolio. They offer:   

  • Ultra-short-term, low-risk investment options: These funds invest in securities that mature within a single day, minimizing interest rate risk and providing high liquidity.   
  • Enhanced diversification: By incorporating Overnight Funds, you can diversify your portfolio and balance riskier investments such as Equity-Linked Savings Schemes (ELSS) and Digital Gold.   

Overnight Funds provide a stable and secure component within your overall investment strategy.

Their reliable performance and low-risk profile make them an excellent choice for conservative investors, contributing to a well-rounded and diversified investment plan.

Things to consider before investing in overnight funds

Overnight funds offer easy access to your cash while earning returns. But before diving in, consider these key factors to ensure they align with your financial goals and risk tolerance:

  • Overnight funds represent the safest category among debt funds, akin to a savings account, prioritising safety and liquidity over high returns.
  • Unlike schemes aiming for optimised returns, overnight funds offer relatively low returns but assure easy accessibility and security for investors' capital.
  • There exists variation among overnight funds regarding returns and expense ratio, requiring investors to assess and select funds with consistent performance and low costs.
  • While compromising returns for safety and liquidity, investors must align overnight fund investments with their financial goals and strategies rather than reacting solely to credit risks.
  • Diversifying investments across various debt funds based on risk appetite and investment horizon is prudent; for instance, while overnight funds offer safety, longer investment horizons may benefit from liquid or ultra-short duration funds holding high-quality bonds.

Comparison with other funds

Choosing the right investment for your portfolio requires careful consideration of various factors. Let's compare Overnight Funds with other popular investment options:

Overnight funds vs. liquid funds

Both offer short-term investment options, but with varying degrees of liquidity and risk. Overnight Funds invest in securities maturing within a single day, offering the highest liquidity and minimal risk. Liquid Funds invest in securities with maturities up to 91 days, potentially offering slightly higher returns but with slightly higher risk.

Overnight funds vs. debt funds

Debt Funds invest in a broader range of fixed-income securities with varying maturities, offering a wider spectrum of returns and risk levels. Overnight Funds, with their ultra-short-term maturity, are ideal for conservative investors seeking a safe and highly liquid investment option.

Overnight funds vs. retirement funds

Retirement Funds are designed for long-term goals, with a focus on growth and income generation. They typically have higher risk tolerances and longer investment horizons. Overnight Funds, with their short-term nature and low-risk profile, are better suited for immediate liquidity needs or as a low-risk component within a diversified retirement portfolio.

Overnight funds vs. equity funds:

Equity Funds invest in stocks, offering the potential for higher returns but also higher risk and volatility. Overnight Funds, on the other hand, provide stable and low-risk returns with high liquidity. They are suitable for risk-averse investors or those seeking a safe haven for a portion of their portfolio.

Key Takeaways

  1. Overnight funds invest in debt securities with a maturity of only one day, such as overnight reverse repos and Certificates of Deposit (CDs).
  2. Due to the extremely short maturity of their investments, overnight funds carry minimal interest rate risk and credit risk.
  3. Investors can easily redeem their investments in a short time, making them highly liquid.
  4. They often offer higher returns compared to traditional bank savings accounts.
  5. Overnight funds are suitable for investors with short-term investment horizons, as a parking ground for funds before investing in other options, and for those seeking a safe and liquid investment option.

Conclusion

Overnight funds in India serve a specific purpose in the spectrum of investment options. They are an excellent choice for those who prioritise capital preservation, liquidity, and modest returns. While not suitable for wealth creation, they play a crucial role in safeguarding and growing surplus funds in a secure and liquid manner. As with any investment decision, it's essential to assess your financial goals and risk tolerance before choosing to invest in overnight funds, ensuring they align with your broader financial strategy.

To check the returns on your investment in overnight mutual funds, you can utilize the Bajaj Finance SIP calculator.

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Frequently asked questions

What is an overnight fund? is the minimum investment amount for overnight funds?

An overnight fund is a type of mutual fund that primarily invests in very short-term debt securities with maturities of one day, offering high liquidity and minimal interest rate risk.

Are overnight funds better than FD?

Overnight funds generally invest in short-term, low-risk instruments such as Treasury bills and overnight deposits, making them a relatively stable investment option. These funds typically offer relatively better returns compared to traditional savings accounts or fixed-term deposits.

Are overnight funds profitable?

Overnight funds aim to provide safety and liquidity rather than high profits. Investors seeking low risk and easy access to their funds may find them suitable.

Who should invest in overnight fund?

Overnight funds are suitable for investors with short-term cash needs and a preference for low-risk, liquid investments, such as individuals looking to park surplus cash temporarily or meet short-term financial goals.

What is the minimum investment amount for overnight funds?

The minimum investment amount for overnight funds varies by mutual fund house.

Are the returns on overnight funds taxable?

Returns from overnight funds are subject to taxation. Short-term capital gains tax applies if units are redeemed within three years, taxed at the investor's income tax slab rate. For redemptions after three years, it incurs long-term capital gains tax at a flat 20% rate with indexation benefits.

Are overnight funds dependent on interest rate changes?

Yes, overnight funds' returns can be affected by changes in prevailing interest rates.

What are the benefits of investing in overnight mutual fund?

Benefits include low risk, liquidity, moderate returns and investment flexibility.

Who are these funds suited for?

Overnight funds are suitable for conservative investors looking for a safe parking place for their surplus funds for a very short duration.

Which is better, a liquid fund or an overnight fund?

It depends on your goals. Overnight funds offer slightly lower returns but unmatched liquidity (you can redeem anytime). Liquid funds offer potentially higher returns but with a slightly less flexible redemption window (typically 1 day exit load).

Overnight funds are designed for the shortest possible investment horizons, often maturing within a single day. Liquid funds are suitable for slightly longer periods, typically ranging from a week to a few months, often up to 3-6 months. However, both types of funds can be held for longer periods if they align with your overall financial strategy.

How long is an overnight fund?

The underlying securities in an overnight fund mature in one business day. Your investment remains in the fund until you redeem it.

What is the rate of interest of an overnight fund?

Overnight fund returns fluctuate based on market conditions. They typically offer lower returns than other debt funds due to their low risk profile.

Is there a lock-in period for overnight funds?

No, overnight funds does not have lock-in periods. You can redeem your investment on any business day. However, some platforms might have a small window (check their policy) after the cut-off time to cancel or modify your request before it is processed at the next day's NAV.

Can overnight funds give negative returns?

While highly unlikely, it's theoretically possible for overnight funds to experience minor fluctuations in their NAV (Net Asset Value). This could occur due to factors like rounding differences in interest calculations or extremely minor credit events. However, these instances are extremely rare and typically insignificant in terms of impact on the investor.

What is the maturity of overnight funds?

Overnight funds invest in debt securities with a maturity of one day, such as overnight reverse repos and Certificates of Deposit (CDs).

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