Context:
Brokers are increasingly guiding clients to liquid exchange-traded funds (ETFs) as a solution for managing idle cash. Liquid ETFs allow brokers to retain funds within their platforms, bypassing regulatory requirements that mandate transferring unutilized funds back to clients’ bank accounts at month-end. As of the latest figures, assets under management (AUM) in liquid ETFs have increased by 31% over the past year, growing from ₹17,200 crore to ₹23,550 crore.
What Are Liquid ETFs?
Liquid Exchange-Traded Funds (ETFs) are short-term debt instruments designed to invest in low-risk assets like money market instruments and overnight securities. These funds typically have a 1-day maturity and are traded on stock exchanges such as NSE and BSE, providing easy access and high liquidity for investors. Dividends from liquid ETFs are calculated daily and reinvested into additional units, credited to the demat account every 30 days.
Who Can Invest in Liquid ETFs?
Liquid ETFs are ideal for:
- Investors looking for a secure way to park unused funds temporarily.
- Those seeking consistent daily returns without committing funds for a long time.
Advantages of Liquid ETFs
- Earn Better Returns: Liquid ETFs ensure that funds earn returns immediately after settlement, unlike idle funds in a margin account or savings account.
- High Liquidity: Easy to buy and sell, ensuring quick access to funds when needed.
- Transparency: Daily updates on portfolio holdings, providing clarity on assets and strategies.
- Convenient Transactions: No need for frequent fund transfers between trading and bank accounts.
- No Securities Transaction Tax (STT): Liquid ETFs are exempt from STT, reducing the cost of investment.
- Low Expense Ratio: Expense ratios for liquid ETFs are generally lower compared to mutual funds.
Disadvantages of Liquid ETFs
- Market Risks: Subject to market fluctuations, which may impact value despite aiming for stability.
- Lack of Control Over Holdings: Investors don’t have control over individual securities within the ETF’s portfolio.
Taxation on Liquid ETFs in India
- Short-Term Capital Gains (STCG): If sold within 1 year of purchase, gains are taxed as short-term capital gains.
- Long-Term Capital Gains (LTCG): If sold after 1 year, gains are taxed at 12.5% (with the initial ₹1.25 lakh of profits exempted per financial year).
Factors to Consider When Investing in Liquid ETFs
- Investment Objective: Ideal for managing short-term liquidity or parking surplus funds temporarily.
- Time Horizon: Best suited for investors with a short-term investment horizon (days to months).
- Risk Tolerance: Liquid ETFs are low-risk but still subject to market fluctuations.
- Credit Quality: Ensure the ETF invests in high credit quality instruments to reduce default risk.
| Parameter | Liquid Funds | Liquid ETFs |
|---|---|---|
| Liquidity | T+1 redemption; some offer instant access | Intraday trading possible; real-time liquidity on exchanges |
| Suitability | Beginners, traditional investors | Market-savvy investors with trading/demat accounts |
| Transaction Cost | No brokerage; possible exit loads for early exit | Brokerage fees apply for buy/sell transactions |
| Expense Ratio | Slightly higher than ETFs | Lower expense ratio; more cost-efficient |
| Accessibility | Available through banks, AMCs, MF platforms | Requires a demat and trading account |
| Customisation | More fund options tailored to risk profiles | Limited ETF choices in market |
| Taxation | <1 yr: taxed as per slab; >1 yr: LTCG with indexation | <1 yr: STCG; >1 yr: LTCG like equity investments |
