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Liquid Funds – What are they, SEBI Regulations, Benefits and more

ICICI Securities 12 Mins 06 Jan 2023

Liquidity is one of the most important criteria that investors look for in their investments. As this is what ensures whether they will be able to use their funds when required or not. While there are different liquid investment options, one of them which stands out is liquid funds. These are debt instruments which are investments in assets which have a maturity tenure of up to 91 days. These funds invest in the most liquid money market instruments where the residual maturity is only up to 91 days. Due to the high liquidity quotient, these funds are regarded as the safest funds in the category.

How do liquid funds work?

Liquid funds invest in commercial papers, treasury bills, government securities and other money market instruments whose maturity period is less than equal to 91 days. This ensures the investors have better capital protection and also high liquidity in their investment portfolio. Since the maturity of the underlying assets of the liquid funds is very short, they are less prone to interest rate changes in the economy which affects debt instruments primarily.

SEBI Regulations regarding Liquid Funds

To understand the liquid funds better and take a call, you need to be aware of the latest SEBI guidelines for this category of fund. These updates have come over the last few years, however, they are very less talked about and thus less known to the investors. Let’s take a look at each of these regulations and their impact on liquid fund investors –

  • SEBI mandated liquid funds to have a minimum of 20% of its fund in liquid assets. This means the liquid funds if they want to retain their category status, then they have to have 20% of their assets under management into assets like cash, and government securities which include G-secs, T-Bills and repos on G-sec. SEBI mandated this to reduce or avoid liquidity crises in the future by the mutual fund houses. The impact of the move has made it easier for investors to redeem their investments as now liquid funds invest in liquid assets. However, on the flip side, the returns from investments in liquid funds have come down a bit more than earlier.
  • The second move by SEBI which will help investors diversify their portfolios more is capping sector-wise investments by liquid funds. In each sector, liquid funds can invest only up to 20% and not 25% like earlier. Moreover, liquid funds have to invest in housing finance companies up to 15% of their AUM as well. Apart from better diversification, investors will have a more secure portfolio.
  • For better and realistic NAV pricing, SEBI mandated mart-to-market strategies for liquid funds. This will also help in discouraging opportunist short-term investors.
  • SEBI made it mandatory for the fund houses to levy exit load if investors are exiting the liquid funds within seven days of investments. This will help in making the funds more liquid as fund managers do not have to deal with very short-term opportunistic corporate investors in these funds.
  • The watchdog of the stock market and investments in India has also mandated the fund houses to invest only in listed securities for the liquid funds. This is to ensure better compliance and safety for the investors.
  • Finally, SEBI banned investments in instruments which has credit enhancements in the past. This will further reduce the risk factors associated with liquid funds.

So, all these measures had been taken by SEBI to ensure better protection and liquidity for the liquid fund investors.

Things to consider while investing in Liquid funds

To make sure you are adding the right fund to your investment portfolio, you need to know certain aspects of liquid funds.

  • Risk and return: The risk and return of liquid funds are quite interesting to follow. While due to the short-term maturity of a maximum of 91 days of the underlying assets of liquid funds, these funds have a very low risk of interest rate changes and capital depreciation. The return of liquid funds like any other debt mutual fund is market linked and varies based on prevailing liquidity and overall interest rate environment. Currently, liquid funds offer return in the range of 5.0% to 6%* which is way higher than the safest investment options like a bank savings account.
  • Taxation: Since these are debt funds, the taxation on these funds is followed like other debt funds only. If the investors hold the fund for less than 3 years, then short-term capital gain taxes as per the investor’s present tax slab will be levied. If it is held for more than three years, then long-term capital gain taxes @20% with indexation benefit will be levied.

Why you should invest in liquid funds?

After knowing the insights about liquid funds, you might be wondering, whether you should add them to your investment portfolio or not, isn’t it? Here are certain points you can consider for adding them to your portfolio –

  • No lock-in period: These funds can be great for investors looking for exceptional liquidity in their portfolio and have no lock-in period. Often it has been observed that debt funds come with a lock-in period and the most liquid funds like ELSS, come with three years lock-in period. However, these liquid funds, even though highly liquid, do not have any lock-in period within which you cannot redeem the investment.
  • Negligible risk: If you are looking for very low-risk investment options, where the return is better than what banks' savings accounts are offering, then liquid funds can be one of the choices.
  • Low volatility: These instruments have very low volatility as well thus, your capital remains safe and secure when you put them in this fund, compared to other debt funds.
  • Instant redemption: Finally, the factor that you can consider is an easy or instant redemption facility for these funds. Most of the liquid funds offer instant redemption facility of even up to Rs. 50,000 in a day for each investor.


Thus, if you are looking for investing in debt funds which have the lowest volatility, and risk factor but better returns probability and most importantly where you can liquidate the investment at any time, then liquid funds can be your way to go.

*Source: Bloomberg

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