Liquid funds have never created a splash in the world of investing — they are not meant to do so. After all, these funds are rather tame, given the limited universe within which they must operate. Investors have not been too excited about them either, merely using them to hold their idle surplus for ultra-short periods. The recent rise in large debt issuances has, however, again brought a little-recognised aspect to the fore.

A typical liquid fund, as institutional investors would surely know, invests mostly in certificates of deposits, commercial papers and treasury bills.

Investors treat them nimbly, often parking money in them for just a few days. The largest among them tend to be short-term surplus generated by corporate houses. Retail investors have little use for liquid funds, unless they have very specific reasons.

One such reason has come up in the recent past, thanks to the debt offerings that were lined up almost one after the other.

PFC, IIFCL and a few other well-known names have made it to this list of issuers. Each of the offers was fairly large in size and investors pumped in considerable dollops of money, leading to over-subscription in several cases.

INVESTOR INTEREST

For retail investors who wanted to access these issues, liquid funds proved to be helpful. Following the advice of brokers, many of them piled up a corpus in liquid funds, only to draw money from it for investing in a debt issue. The latter, they were aware, would be listed quickly, not long after the subscription and allotment processes were completed.

A positive listing (that is, at a premium to the offer price) would give rise to a perfect opportunity: A quick exit at a profit. The proceeds would finally go back to the liquid fund, to be utilised similarly when the next debt issue came along.

The point to note here is that the allotment and listing are very system-driven these days. An investor can look at the next opportunity without losing much time.

It can be argued that the same can be achieved by another means — a current account in a bank. However, a typical current account earns no interest; thus, it yields nothing on the days when money lies idle in it.

A liquid fund, however, invests in a range of money market instruments, which are essentially short term in nature. For corporate investors, such a fund is a handy tool, marked by the convenience of entry and exit, limited risks and low expenses.

CHASING RETURNS

This brings us to the question of returns. A liquid fund is not right for investors who are simply chasing returns. It is for those who are seeking a temporary hub for their idle cash. Businesses use liquid funds all the time, a strategy that is often marked by quick entry and exit — which means the average fund’s corpus can change rapidly over a period of time.

Yet, besides meeting their treasury management needs, institutional investors do require some returns, however modest.

Going by the recent trends, a well-managed liquid fund may generate 8 per cent or so for the entire year. I must mention here that one year is not the ideal time frame for these funds. There are better options for those who want to stay invested for one year. Money in liquid funds usually stays for a few weeks. In fact, even three or six months would be a lot of time for these funds. After all, investors can choose 3-month or 6-month fixed maturity plans that would keep their money locked in for fixed periods.

Going by their annual scores, the returns produced by most funds in this category run neck to neck.

As investors who have tested the waters would agree, the average returns are not unattractive, given the narrow space within which these funds operate.

For those who want to confine themselves to conservative options, liquid funds have significant merits. The more prominent among them have plenty of following, a trend underlined by their large asset sizes.

Market participants, who expect to optimise returns, look at winning combinations of asset classes.

Take, for instance, the returns aggregated by a liquid fund and the recent tax-free bond issue by a public-sector giant. The annualised yields for bond investors are fairly sharp in this case — 8.43 per cent per annum for 10 years, 8.79 per cent for 15 years and 8.92 per cent for 20 years. Not too unfair for retail participants.

KNOW THE RISKS

Despite all their advantages, liquid funds are not without risks. Those who wish to use these funds as mere leveraging tools should stay warned. There are elements like taxation to consider. If you wish to tap the debt market (by keeping liquid funds at the base of your strategy), the planned exit from the asset classes would probably lead to short-term capital gains.

Besides, the debt floatation could be listed at a price lower than the offer price. That would probably negate the possibility of an early exit. Certainly, a first-day exit will be ruled out if the listing price is unattractive.

An experienced investor will, however, not be burdened by disappointments such as this. That is because of the multiple opportunities that the market is expected to throw up in the days ahead.

A number of leading companies are expected to tap the bond market in the future.

The trick is to repeat the process every time a high-quality issue shows up.

Timing the entry and the exit is also critical. Such timing should match the investor’s overall financial objectives.

Investment advisers, thus, have to be alert and advise their clients accordingly. As always, qualified professionals must be consulted before cheques are written.

The author is director, Wishlist Capital Advisors