Why you should opt for Overnight funds over Savings Accounts

Why settle for less when you can earn more? If that thought resonates with you then you have every reason to choose an Overnight Fund to park your short-term surplus money instead of a savings account or a short-term fixed deposit.

Now, some of the first thoughts that occur to you may run along the lines of “why leave the safety and flexibility of a savings bank account and make comparisons such as overnight fund vs savings account or overnight funds vs FD?”

Here’s why, at present the balance in your savings bank account most likely earns you an interest of 3%-3.5% pa. The rate of return is almost the same on term deposits with low maturity. However, overnight funds are minimal risk investment options that can fetch you annualised returns of over 6% pa.

What are overnight funds?

Debt oriented mutual fund schemes investing in securities having a maturity profile of one day are called overnight funds.

How risky are overnight funds?

The Potential Risk Class (PRC) matrix, rates Overnight funds as A-1, signifying the highest quality for credit and the least risk due to change in interest rates.

What are the advantages of investing in overnight funds?

1. No credit risk due to investing only in T-bills issued by the RBI.
2. No interest rate risk, given that instruments have a maturity of 1 day only.
3. Better return prospects as compared to current savings account rates.
4. No exit load or lock-in period.
5. High liquidity
6. Liable to earns returns from day one since the units are allocated on the previous day’s NAV

Who should invest in overnight funds?

Overnight funds can be invested by anyone whose surplus ends up idle in a saving bank account or in a bank fixed-deposit for a short duration. Overnight funds are also suitable to small businesses that receive a large sum of money from their customers and have a short window before making a payment to their suppliers. A non-brainer if you have a current account.

Where do overnight funds invest?

Overnight funds predominantly invest in securities maturing overnight such as Tri-party Repos (TREPS) and reverse repos. They may also invest a small portion of their portfolio in Treasury Bills. However, they cannot invest in credit enhancements and structured obligations.

What makes overnight funds more attractive as compared to savings bank account and term FDs?

Since the return potential of overnight funds is closely linked with the level of repo and reverse repo rates in the country, they become more attractive when the rates are already high & steady or even low but rising.

Banks are less efficient in passing on the hikes and reductions in repo rates to their customers. Thus, if repo rates rise suddenly, banks resist hiking interest rates on savings bank account immediately, as long as, they can mobilise funds to the current and savings bank accounts at competitive cost or garner low cost term deposits.

Banks may tend to be less efficient in passing on the hikes and reductions in repo rates to their customers. Thus, if the repo rate rises suddenly, banks resist hiking interest rates on savings bank accounts immediately, as long as, they can mobilise funds to the current and savings bank accounts at a competitive cost or garner low cost term deposits.

In short

Borrowing rates and liquidity conditions in the overnight market vastly affect the return potential of overnight funds. That said, going by the track record of the overnight funds for the past 8-10 years, they seem to have emerged as a better alternative to current and savings bank accounts.

If you have a time horizon ranging from a day to a week, overnight funds may just be the right choice for you.