Last Updated on May 24, 2022 by Aradhana Gotur

Stock markets are touching an all-time high and experts believe that the rally is because of increased liquidity in the market. Retail investors’ participation in the market catalyses the process. 

One way to calculate the retail investors’ participation in the market is to check the mutual fund inflow. A new attraction in the mutual fund arena is the overnight mutual funds. Let us dive deep in to understand the features of the overnight fund, the risks and more. 

What is an overnight mutual fund?

Overnight mutual funds are ultra-short term funds that accumulate returns from debt-based investment assets or money market instruments with a maturity of a single day

Investors can redeem the capital invested in an overnight fund after 24 hours of investment. This makes them more liquid than any other debt fund. 

Features of overnight mutual fund 

Overnight mutual funds are one of the most secure forms of financial instruments. However, before making any decision, one should consider the following features:

  • Overnight funds are highly secure investments.
  • With low risk comes low returns. Being overnight funds, you cannot expect enormous returns on your capital. 
  • Different overnight funds allocate capital to different financial instruments. 
  • Investors should carefully research and analyze the fund before putting their hard-earned money into overnight funds.
  • Overnight mutual funds are as liquid as a bank’s savings account. 
  • Overnight funds may be considered if your investment horizon is less than a mth. 

You can also choose various other open-ended funds to invest in if your investment horizon is between 2-7 mth. 

How do overnight mutual funds work? 

To understand the working of overnight mutual funds, you need to understand what investment products they allocate capital to. These products are as follows:

Investment products allocated by overnight mutual funds 

The funds pick Collateralized Borrowing And Lending Obligation (CBLO), overnight reverse repo rates, Certificate of Deposits, Commercial Papers, and other money market instruments that offer fixed returns. The portfolio holdings of an overnight fund shuffle every night. 

Also, the first and foremost rule an overnight fund follows is not to invest in risky debt instruments. The risky debt instruments are those instruments that have the risk of default, such as in corporate bonds.

Overnight funds earnings 

Debt holdings pay interest on the capital. They do not trade based on price. Therefore, earnings for overnight funds are via interest rates. 

Moreover, when the liquidity in the market is high, then the interest rates decline, and investors earn less. On the contrary, when the liquidity in the market is tight, then the interest rates are generally hiked by the government, and the funds start giving out better returns to the investors. 

Overnight funds are closely related to the bond and other capital market instruments’ interest rates. Thus, market timings matter while investing in overnight mutual funds. 

Who should invest in an overnight mutual fund? 

Investors with less risk appetite usually invest in an overnight fund as it is considered safer compared to any other financial instrument. Overnight funds are considered ideal for people starting their investment journey. 

This, however, does not mean that experienced investors do not park their funds in overnight mutual funds. For instance, if High Net Worth Investors (HNI) are about to receive extra funds, they prefer pit-stopping their capital in overnight mutual funds, until the time they do get a better investment opportunity. This is because of the safety that overnight mutual funds provide.  

Things you should know as an investor of overnight mutual funds

Before investing in overnight mutual funds, you need to know these essential things :

  • Overnight mutual fund’s portfolio shuffles every fortnight/ or on the day after the trading session. 
  • The return of an overnight mutual fund depends upon the liquidity and interest rates (borrowing rate) in the market. 
  • As per the mandate, an overnight fund has to allocate funds into the lowest-risk debt instruments. Therefore, the investor’s capital is safe and does not have any default and interest risk.
  • The expense ratio of an overnight mutual fund is generally less than 1% as they are managed passively. 

Taxability of overnight mutual funds

The taxation policy of overnight mutual funds is similar to a debt fund. By investing in overnight mutual funds, investors earn capital gain and dividend income. The dividend income is taxable as per investors’ tax slab. If investors buy at a lower price and sell at a higher price, they are taxed on the profit/gains commonly called capital gains tax.

Capital gain tax depends upon the holding tenure of the investor. They are classified as: 

  • Short-Term Capital Gain Tax
  • Long-Term Capital Gain Tax

Short-Term Capital Gain Tax

When an individual is invested in any debt, debt-oriented funds or unlisted equity for up to three yrs, the gains are considered short-term capital gains. The tax is deducted as per the income-tax slab. 

Long-Term Capital Gain Tax

Unlike a short-term capital gain tax, in this case, if the investor stays invested for more than three yrs, then it will be subjected to long-term capital gain tax. Generally, the LTCG tax rate is lower as compared to STCG due to the indexation benefit. 

However, there is no LTCG on the overnight fund as the holding tenure is generally fortnight and a maximum of thirty days. Therefore, due to the investment horizon, which is significantly less, there is no scope for LTCG. 

Advantages of overnight mutual funds 

These are some of the significant advantages of overnight mutual funds: 

Low risk 

Overnight mutual funds are the least risky out of all the available mutual funds because, as per the mandate, fund houses have to invest in low-risk debt instruments. Also, the possibility of the default in interest payment is next to impossible. Moreover, the volatility is also low. Therefore, overnight price or interest rate does not fluctuate. 

Saves from market volatility 

All the other markets are highly volatile, especially the equity markets. Therefore, the risk exposure is high in volatile markets. Also, the most significant advantage is the investment horizon. It saves investors from losing capital. The overnight fund remains unaffected even if the central bank makes any changes to the interest rates. 

Easy entry and exit 

There is no entry and exit load on overnight mutual funds. Thus, investors can redeem the entire amount within a day without even paying any redemption fee to the fund house. 

Low cost 

The expense ratio of an overnight mutual fund is less as it is passively managed. Therefore, the investment cost is low. 

Bottom line

The mutual fund industry has truly revolutionised investments in India, launching customized products to cater to every type of investor and investing style, especially for retail investors. Amongst the many options, the overnight fund is an interesting scheme. As risk-averse as it can get, it aims to allocate investor funds in debt instruments and others for a period of 24 hours, promising the safety of capital and interest. 

However, it is important to research the fund thoroughly and understand your risk appetite before investing.   

Ayushi Mishra
Inline Feedbacks
View all comments
55,00,000+ users trust Tickertape for Investment Analysis!
55,00,000+ users trust Tickertape for Investment Analysis!
55,00,000+ users trust Tickertape for Investment Analysis!
55,00,000+ users trust Tickertape for Investment Analysis!

The blog posts/articles on our platform are purely the author’s personal opinion and do not necessarily represent the views of Anchorage Technologies Private Limited (ATPL) or any of its associates. The content in these posts/articles is for informational and educational purposes only and should not be construed as professional financial advice. Should you need such advice, please consult a professional financial or tax advisor. The content on our platform may include opinions, analysis, or commentary, which are subject to change, without notice, based on market conditions or other factors. Further, the use of any third-party websites or services linked on the website is at the user's discretion and risk. ATPL is not responsible for the content, accuracy, or security of external sites. Investments in the securities market are subject to market risks. Read all the related documents carefully before investing. Registration granted by SEBI, membership of BASL (in case of IAs) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors. The examples and/or securities quoted (if any) are for illustration only and are not recommendatory. Any reliance you place on such information is strictly at your own risk. In no event will ATPL be liable for any loss or damage including without limitation, indirect or consequential loss or damage, or any loss or damage whatsoever arising from loss of data or profits arising out of, or in connection with, the use of this website.

By accessing this platform and its blog section, you acknowledge and agree to the Terms and Conditions of this website, Privacy Policy and Disclaimer.