Mutual Fund Overnight Schemes (MFOS)

Introduction

In India, mutual funds have emerged as a popular investment choice due to their diversification, professional management, and liquidity. Among the many categories of mutual funds, Overnight Mutual Fund Schemes (MFOS) are a relatively new and innovative option that has gained attention from investors looking for a safe and short-term investment avenue.

An Overnight Mutual Fund Scheme (MFOS) is a type of mutual fund that primarily invests in very short-term debt instruments, typically with a maturity of one day. These schemes are designed to provide investors with a safe, liquid, and low-risk investment option that offers higher returns than traditional savings accounts while maintaining a very short investment horizon.

In this blog, we will explore Mutual Fund Overnight Schemes in detail, covering their definition, structure, advantages, risks, and comparison with other investment options. Additionally, we will also discuss the regulatory framework, performance, and key considerations when investing in MFOS.

What Are Mutual Fund Overnight Schemes (MFOS)?

Overnight Mutual Fund Schemes are open-ended debt mutual funds that invest exclusively in overnight instruments, such as short-term government securities, inter-bank call money, and repos (repurchase agreements), which mature within one business day. These funds aim to provide liquidity, preserve capital, and offer a stable return over the short term.

Since the investments are held for a very brief period (usually overnight), they are considered one of the safest types of mutual funds, offering very low risk and minimal price fluctuations.

Key Features of Mutual Fund Overnight Schemes

• Investment Horizon:
  • As the name suggests, MFOS invest in overnight instruments, meaning the investment is typically held for a single day. This makes them an ideal option for investors looking for very short-term liquidity.
• Low Risk:
  • MFOS primarily invest in highly liquid instruments, such as government securities and repurchase agreements, which are very low in risk. This makes them one of the safest investment options in the debt mutual fund category.
• Liquidity:
  • Overnight schemes offer high liquidity, which means that investors can redeem their investments at any time without significant risk to the capital or returns. However, since the investments are short-term in nature, returns may be lower than more aggressive investment options.
• Returns:
  • The returns from MFOS are typically in the range of 3% to 5% per annum, which is higher than the returns offered by a traditional savings account or a fixed deposit. However, these returns are usually lower compared to more volatile investment options like equity mutual funds.
• Transparency and Regulation:
  • MFOS are regulated by the Securities and Exchange Board of India (SEBI), which ensures that the schemes adhere to all regulatory requirements for investor protection. Additionally, as these funds invest in government securities or highly rated instruments, the transparency and risk management mechanisms are robust.
• No Entry/Exit Load:
  • Overnight funds usually do not have any entry or exit loads, which makes them a cost-effective investment choice. Investors can enter and exit the fund without incurring additional charges, making it easier for short-term investments.
• Daily NAV (Net Asset Value) Updates:
  • MFOS update their NAVs daily, reflecting the overnight investments and changes in the value of underlying securities. The NAVs are typically stable, and fluctuations are minimal.

How Do Mutual Fund Overnight Schemes Work?

Mutual Fund Overnight Schemes invest in securities with very short-term maturity. These include:

• Overnight Repo (Repurchase Agreements):
  • These are short-term loans where one party sells a security to another with the agreement to repurchase it the next day. The seller pays interest on the loan, and the buyer holds the security as collateral.
• Treasury Bills (T-Bills):
  • T-bills are short-term government securities that mature in a year or less. Overnight funds may invest in these T-bills to ensure stability and liquidity.
• Cash Management Bills:
  • Issued by the Indian government, these bills are used to manage short-term liquidity mismatches in the market. Overnight funds may invest in these bills to achieve their investment objectives.
• Call Money Market:
  • MFOS also invest in the call money market, where banks and financial institutions borrow and lend money for short periods, often overnight.

These investments are highly liquid and generate interest income, which is distributed to investors in the form of returns. The maturity period of overnight instruments is typically one day, meaning that any investments made are quickly redeemed and reinvested the following day.

Advantages of the Schemes

1. Safety and Security:
   • The primary advantage of MFOS is that they are low-risk, as they invest in highly secure short-term instruments. With a focus on overnight investments, the exposure to market fluctuations is minimized, making them ideal for risk-averse investors.
2. Liquidity:
   • MFOS offer great liquidity, meaning that investors can redeem their units quickly. These funds are designed to provide easy access to funds for those needing quick liquidity, especially in volatile or uncertain market conditions.
3. Higher Returns Compared to Savings Accounts:
   • MFOS typically offer returns higher than savings accounts or short-term deposits. For investors with an extremely low-risk appetite, MFOS provide a better alternative to parking funds in a savings account, while offering the benefit of flexibility.
4. Diversification:
   • These funds diversify investments across various overnight instruments, such as government securities and repo markets. This diversification provides a balance of safety and returns, ensuring that the risks are spread across different asset classes.
5. Low Cost:
   • Since there is no entry or exit load in most MFOS, they offer a cost-effective way for investors to earn returns without paying additional charges. Furthermore, the management fees are generally lower due to the passive nature of these funds.

Disadvantages of the Schemes

1. Lower Returns:
   • The biggest disadvantage of MFOS is that they offer relatively lower returns compared to equity-based or long-term debt mutual funds. For investors seeking high returns, MFOS might not be an ideal option.
2. Not Suitable for Long-Term Investors:
   • Since the investment horizon of MFOS is just one day, these funds are not suitable for long-term investors looking for significant capital appreciation. The returns generated are generally modest, and investors may have to look at other schemes for more significant gains.
3. Interest Rate Risk:
   • Although the risk is low, MFOS may still be subject to changes in interest rates. If interest rates rise, the value of bonds or securities may decline, which could impact the returns generated by the scheme, albeit to a limited extent.
4. Inflation Risk:
   • Given that MFOS offer modest returns, there is a possibility that inflation could erode the purchasing power of the returns. Therefore, these schemes are better suited for short-term investments rather than as a long-term investment vehicle.

Taxation of Mutual Fund Overnight Schemes

The taxation of MFOS follows the general taxation norms applicable to debt mutual funds. Here’s a breakdown of the tax treatment:

• Short-Term Capital Gains (STCG):
  • If the investment is redeemed within three years, the gains are considered short-term. The tax on short-term capital gains is 15% (plus applicable surcharge and cess).
• Long-Term Capital Gains (LTCG):
  • If the investment is held for more than three years, the gains are classified as long-term. The tax rate on long-term capital gains is 20% with indexation (plus applicable surcharge and cess).

Additionally, dividends received from MFOS are subject to Dividend Distribution Tax (DDT), which is taxed at the rate of 29.12% for individuals, including the surcharge and cess.

Popular Mutual Fund Overnight Schemes in India

Several Asset Management Companies (AMCs) offer Overnight Mutual Fund Schemes to cater to the growing demand for short-term, liquid, and low-risk investments. Some of the popular MFOS available in India include:

1. Nippon India Overnight Fund
2. HDFC Overnight Fund
3. ICICI Prudential Overnight Fund
4. Aditya Birla Sun Life Overnight Fund
5. Kotak Overnight Fund

These schemes have been well-received by investors due to their low expense ratio, strong performance, and the credibility of the fund houses offering them.

Conclusion

Mutual Fund Overnight Schemes (MFOS) serve as an excellent option for investors looking to park their funds in a low-risk, liquid, and short-term instrument. With a focus on providing stability and safety, these funds are ideal for conservative investors or those looking to manage idle cash for a brief period. While the returns are lower compared to other asset classes like equity, they offer a significant edge in terms of safety, liquidity, and transparency.

MFOS can be a suitable option for those looking for a temporary parking space for their funds while they await better investment opportunities or need liquidity in the short term. However, it’s important for investors to understand the trade-off between risk and returns and align their investment goals accordingly. If used wisely, MFOS can be a valuable component in an investor’s diversified portfolio.