Overnight Funds
Overnight funds are a type of debt mutual fund that invests in securities with a maturity of just one business day. These funds typically lend to regulated corporates such as banks, insurance companies, mutual funds, and non-banking financial companies (NBFCs) for very short durations.
Key Features of Overnight Funds:
- Short-term Duration: They invest in debt and money market instruments that mature in just one business day, ensuring very short investment horizon.
- High Liquidity: Investors can buy or sell units on any business day, with easy and quick access to their money and typically no exit load.
- Low Risk: These funds carry minimal credit risk and virtually no interest rate risk because the maturity is only one day, making them one of the safest options among debt funds.
- Daily NAV Calculation: Net Asset Value (NAV) is calculated daily, reflecting the interest earned on the securities held for the one-day period.
- Stable and Predictable Returns: While returns are not very high, they are consistent and less volatile compared to other debt funds.
- No Lock-in Period: Investors have the flexibility to redeem their investments anytime without penalties.
- Capital Preservation: These funds prioritize the safety of capital with minimal exposure to market volatility.
- Reinvestment Cycle: The fund manager reinvests proceeds from maturing securities into new overnight instruments daily, maintaining the one-day maturity profile.
How Does Overnight Fund Works:
Overnight funds work by investing your money in very short-term debt securities that mature the next business day. Here’s how they operate in a step-by-step manner:
- When you invest in an overnight fund, your money is pooled with other investors’ funds under the management of a fund manager.
- At the start of each business day, the fund’s total assets (AUM) are held in cash.
- The fund manager uses this cash to purchase high-quality debt instruments that specifically mature in one day. These instruments include overnight repos (TREPS), treasury bills, commercial papers, certificates of deposit, and other similar securities with a one-day maturity.
- Because all securities mature the very next day, the invested principal along with accrued interest is received back the following day.
- The fund manager then reinvests the redeemed amount into new overnight securities that mature the next business day, maintaining a continuous cycle of daily maturity and reinvestment.
- This daily cycle keeps the fund’s portfolio very short-term, minimizing interest rate risk and credit risk.
- You can hold your investment for as short as one day or longer, with the ability to redeem anytime without exit loads in most cases.
- The Net Asset Value (NAV) of the fund is calculated daily based on the interest accrued on the invested securities.
Because the securities mature every day, your capital is very safe, liquidity is high, and returns are stable but modest. This mechanism makes overnight funds ideal for parking surplus funds temporarily with minimal exposure to market fluctuations.
Pros and Cons:
Pros
- High Liquidity: Investors can redeem their money on any business day without exit loads or penalties, providing easy access to funds.
- Safety and Low Risk: These funds invest in very short-term debt instruments maturing in one day, minimizing credit risk and interest rate risk.
- Stable and Predictable Returns: Returns are generally stable and less volatile compared to other debt funds, with low exposure to market fluctuations.
- Better than Savings Accounts: Overnight funds often provide better returns than traditional savings accounts while maintaining safety.
- No Lock-in Period: Investors have the flexibility to withdraw their investment anytime.
- Low Cost: Typically, these funds have a low expense ratio due to passive management.
- Suitable for Short-Term Parking: Ideal for investors looking to park surplus funds overnight or for very short durations safely.
- Daily NAV Calculation: The fund’s value is updated daily to reflect accrued interest on the underlying securities.
Cons
- Modest Returns: Overnight funds offer relatively low returns compared to other mutual funds or longer-term debt funds, limiting wealth accumulation potential.
- Not Suitable for Long-Term Goals: Because of low returns, these funds are not designed for long-term investment or wealth creation.
- Tax Implications: Depending on the holding period, gains can be taxed at the investor’s income tax rate, which may reduce net returns.
- Inflation Risk: With modest returns, the purchasing power of invested capital may not keep pace with inflation.
- Limited Growth Potential: The focus on safety and liquidity means these funds do not capitalize on higher-yielding, slightly longer-term instruments.
