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Retail investors latch to liquid funds bandwagon

An instrument primarily loved by institutional investors is increasingly finding a place in retail investors' portfolio as it offers higher returns in short-term than a savings account and helps averaging the cost during volatile markets.

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In India, small mutual fund investors are coming of age. They have startled everyone with their behaviour of parking additional funds in equity funds when the stock markets are in a turmoil.

While equity mutual funds are primarily held by individual investors, there is another category of funds ruled by institutional investors where retail investors are slowly showing interest. Liquid funds are increasingly seeing applications from individual retail investors as per data collated from Association of Mutual Funds in India (Amfi). Liquid funds are schemes where one can park money for the short-term without any entry or exit load. These schemes carry the lowest interest rate risk among debt funds as they primarily invest in fixed-income securities with short maturity.

The number of folios held by retail investors in liquid funds has grown to 2.63 lakh by 31 December 2015 as compared to 1.68 lakh folios held at the end of September 2012. Folios are numbers designated for individual investor accounts. However, one individual may have multiple folios.

The assets held by retail investors in liquid funds in the 54 schemes available in the market too has shot up more than three times to Rs 3,886.67 crore in December 2015 as against Rs 1,003.03 crore held at the end of September 2012, as per Amfi. Though the number of folios held by retail investors form a bulky 75% of the total liquid fund folios, the assets held by them are barely 1.67% of the total Rs 2.33 lakh crore.

Even the new channel of MF Utility has been seeing liquid fund transactions trickle in. "Last month, Rs 6 crore amount was transacted in liquid funds out of the Rs 52 crore transacted through us," said V Ramesh, managing director and CEO of MF Utilities India.

What is leading retail investors to these funds, which have primarily been the treasure trove of institutional investors who look to idle-park funds for as low as a day and pull out during events such as quarter ends, advance tax payments and the likes?

Vidya Bala, head of mutual fund research at Fundindia.com, says, "The awareness per se has increased that liquid funds offer higher returns on the surplus as compared to savings bank account."

While savings banks offer 4% interest on money resting during the interim period, select banks have been offering 6-7%. However, these high interest rates are offered only on higher sums parked in the bank accounts.

Apart from those who have initiated use of liquid funds instead of bank accounts, she says, there are another set of investors who have taken a fancy for liquid funds. "Select investors are resorting to liquid funds to park their emergency funds. That apart, there are investors who invest in liquid funds as they wish to invest in equity mutual funds through a systematic transfer plan (STP) when equity markets are volatile. This is a growing trend among investors who come in through advisors and are looking to invest a lumpsum amount," Bala adds. STP is a facility wherein smaller quantum of money is shifted from liquid funds to equity scheme of choice to take benefit of averaging the cost during volatile markets.

Though the STP route has been in existence and market volatility has forced retail investors to opt for STP, there is a hidden motive behind the increasing retail folios under liquid funds each quarter.

"Many retail IFAs have realised that even though they receive a higher trail commission of 1% on equity mutual fund assets as against 0.6-0.75% trail commission for liquid fund assets, it would be easier to target investors for a lower-risk scheme of liquid funds," divulged a national distributor not willing to be named.

"There is also a decent amount of investor education that is leading this change, especially in B15 locations. There are huge number of liquid fund folios which have been logged in from smaller locations through the facilities where one can purchase and redeem through SMS," the distributor added.

No wonder then that a higher share of investors – 61% - come in through the distributor channel in the tier-1 cities, while 27% investors invest in liquid funds directly.

Whether you are looking at STP entry into equity markets or looking to invest in liquid funds as an option of earning better than bank accounts, there are risks that you shouldn't forget about.

"Though the risk under liquid funds is limited, they aren't immune to falls. The returns on liquid funds are linked to the money market and there will be a dip based on the marked-to-market rates. An example to point here would be the July 2013 when there was an unusual fall in debt market and liquid funds gave negative returns. It was recouped in a week as under liquid funds, the papers are held till maturity. The returns would be higher than fixed deposit returns," warns Bala.

She recommends investors not to panic when there is an unusual drop as it can be recouped in a matter of weeks.

But how do you go about selecting the best of the pack? "Return differential among funds is not too high. So one need not scout for the best performing fund, instead opt for an established fund house with sizeable assets as asset size is crucial for liquid funds. If you are looking to invest in a particular equity fund through STP, then you invest in the liquid fund with the same fund house," suggests Bala.

Consider taxation too while investing. Dividends received under liquid funds aren't taxed, however, gains made under these schemes are added to your income just like bank account interest.

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