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Understanding bond funds and liquid funds

Monday, August 01, 2016
By I. V. Subramaniam

I. V. Subramaniam
Director - Quantum AMC and  MD & CIO- Quantum Advisors

I have been told that it is better to park money in liquid funds for short periods rather than keep it in a savings bank account. For how long can one invest in liquid funds safely?
—Sagar Gaikwad, Chembur

Firstly no market-related investment is risk free, be it equity or liquid. While liquid funds are not as “risky” as equity funds or long term debt funds, they are not without their share of risks.

Liquid funds are generally looked at as an alternative to savings bank account to maintain contingency funds. Both have better liquidity (as compared to Equities and FDs) and are meant for investors who are risk averse. As far as time periods for investing go - Liquid funds invest primarily in money market instruments like certificate of deposits, treasury bills, commercial papers and term deposits. Since liquid funds are relatively less risky than other funds, you could invest in liquid funds for as long as you wish. However, I always suggest that investors should consult their financial advisors before taking any major investment decisions.

I have retired recently and would like to invest a portion in a couple of equity MFs through 5 year SIP. Will it be in order if I invest in liquid and ultra-short term funds for 1 or 2 years and then do STP in equity MF scheme? I have invested various amounts in FD for 1,2,3,4 years in order to earn income on idle money. Thanks in advance. I do not fall under any tax slab.
—Pramod Kumar, Malabar Hill

Congratulations on the beginning of your second innings. When it comes to asset allocation I generally suggest people to INVEST A LARGER PROPORTION in equities if you are young and proportionately reduce it as you age. Even at the time of retirement, I would advise a good amount of investment in equities- as long as you do not need any cash flows from this investment. This will allow your investment to grow and beat inflation, subject to high market risk. The accumulated equity assets could not only be of use to you, but can also is a great asset to bequeath for the next generation However if you need regular income from your investments, then lesser investments may be made in equities as you retire, and more amount in debt. I do not know all the details of your needs etc- but purely based on your question, I feel that you could straightway start a SIP in equities rather than first invest in debt funds and then do an STP into equity. Do consult your financial advisor before taking any investment related decisions.

What are the risks involved in mutual fund investment?
—Kiran Vaidya, Sion

Risk of investing in any instrument can broadly be categorised into two:

Permanent loss of capital- example investing in a company that goes bust.

Volatility in the price of the investment that you hold, Eg. It could be the price of the share that you hold or the unit value of the units of the mutual fund that you hold.

Both the above risks are reduced in the case of a mutual fund- since the investment is diversified across a number of stocks in an equity mutual fund or across a range of fixed income instruments- in the case of liquid or debt fund. To summarize, mutual fund investment can be volatile depending on market conditions, but the risk is lower compared to holding direct equity or holding a bond.

Sometimes an asset class can be more volatile than it normally is. In such cases you can reduce the risk by investing in multiple asset class such as equity mutual fund, debt mutual fund or gold fund. Or you can straightway invest in a multi asset fund which reduces the risk of having a high exposure to one asset class and gives your investment portfolio the much needed diversification.

To get a general idea of risk involved in a particular mutual fund product you could refer the Product Label of that scheme. Mutual fund regulator SEBI has introduced ‘Riskometer’ that shows the level of risk associated with that particular scheme.

Can I buy mutual fund units in my fiancé’s name and then gift it to her? Also, I have a few units of a mutual fund can I transfer them to her name?
—Aman Kumar, Kalyan

Buying mutual fund units in your fiancé’s name would make it a third party payment. By law, such payments are not accepted by mutual funds, except in case of payment made for a child by his parents/grandparents/related persons, or in case of payment by an employer for an employee, or by a custodian on behalf of an FII/FPI or a client.

As far as transfers are concerned, according to SEBI regulations mutual fund units are freely transferable. However mutual funds restrict the transfer by way of a disclosure in the offer documents, by issuing account statement instead of a unit certificate. If unit certificates are obtained (by paying the required stamp duty and completing the formalities) then they can be transferred. Additionally, if your units are held in the demat form they can be freely transferred, according to demat regulations.  However I would rather suggest, instead of undergoing all the hassles involved in a transfer, that you add your fiancé as a joint holder in your account. This way she becomes a co-owner of the units. Or your fiancé can be made a nominee in your account.

I have been investing via SIPs for three years in a few funds. In March 2015 I was getting an IRR of 30%. Since March, I stopped investing in these funds and started investing in other funds. Now I see that the IRR for the old funds has dropped to 17%. Should I cash out immediately? I do not need the cash but I feel if I stay invested in the funds the IRR will fall further and I will lose more money.
—Saloni Vora, Dadar

Investors need to understand that Equities has a potential to give high returns, but it is also a high risk asset class. So, the trick is, the longer you stay invested the chances are your investments will average out market volatility and generate good long term returns. Also, you must only cash out your investments in two conditions – If you have met your financial goals or if you are in a need of some urgent money. I understand it is neither of a situation for you, so in my view - stay invested. SIPs are one of the best ways to invest in equities. Therefore you should re-start your SIP after analyzing the suitability of the fund for you - based on your risk appetite. In addition to SIP, whenever the market declines, if you add a little more capital to your investments, then your IRR could be further enhanced. Therefore, as long as it is a good fund that you are invested in, don’t be scared of market volatility or of the declining IRR. Over a long period of time, the potential to earn higher return from this asset class is still good. I would also suggest that you consult a financial advisor before taking any investment related decision.

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