Overnight Mutual Funds – Overview, How They Work, Advantages, Taxation

Last Updated on Jul 30, 2024 by Anjali Chourasiya
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 as per the Budget 2024

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 TaxLong-Term Capital Gain Tax

Short-Term Capital Gains (STCG)

If you sell your debt fund units within three years (36 months), the gains from these investments are considered short-term capital gains. According to the new budget, these gains will be taxed according to your income tax slab rate.

Long-Term Capital Gains (LTCG)

For debt funds held for over three years (36 months), the gains are categorized as long-term capital gains. The key points to note under the new budget are:

Tax Rate: The tax rate for long-term capital gains on debt funds is now a flat 12.5%, regardless of the amount of gain.No Indexation Benefit: The benefit of indexation, which previously allowed investors to adjust the purchase price of their assets for inflation, has been removed for debt funds. This means that the entire gain from selling a debt fund after three years will be taxable at the flat rate of 12.5%.

Summary

Capital Gains TaxDescriptionShort-Term Capital Gains (STCG)If you sell your debt fund units within three years (36 months), the tax will be as per your income tax slab.Long-Term Capital Gains (LTCG)For debt funds held for over three years (36 months), the tax rate is now a flat 12.5% without indexation benefits.

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.   

Content Writer at TickertapeWith a wealth of experience as a content writer at Tickertape, Aayushi is passionate about simplifying complex investment modules for the platform’s audience. Her writing offers a fresh perspective on the financial world, keeping readers captivated with the latest industry developments. Aayushi’s ability to break down financial jargon into easily digestible content sets her apart as a writer who truly understands the needs of her readers. Latest posts by Ayushi Mishra (see all)