Overnight funds back in demand as interest rates start to firm up

Overnight funds - considered the safest category among debt mutual funds - are witnessing fresh interest from investors looking to shuffle their portfolios. With the stock market facing headwinds and interest rates expected to rise further, investors are parking money in overnight funds, where returns have increased to almost 5% from an average of 3% a few months ago.

Fund managers have also been recommending overnight funds to avoid mark-to-market loss as interest rates are moving up, while equity investors are putting money in this category for preservation of capital, before bringing them back to equity.

"Overnight fund returns move with repo rate and do not carry any mark-to-market risk. That's why-risk averse investors park in this category," says A Balasubramanian, MD, Aditya Birla Sun Life Mutual Fund.

Overnight funds are the safest among debt funds because they invest in securities with residual maturity of a day.

Since October 2021, when the equity market downfall started, savvy investors have started using overnight funds to park money. The number of folios in the category rose from 1.55 lakh in October 2021 to 5.85 lakh in May 22, with average assets under management rising from ₹1.16 lakh crore to ₹1.36 lakh crore. In the same period, debt MF AUM shrunk from ₹14.89 lakh crore to ₹13.62 lakh crore

"Elevated market volatility, minuscule risk in this category and quick redemption timelines seem to have attracted direct equity investors seeking to temporarily park funds," says Nirav Karkera, head of research, Fisdom. Many investors who believe markets are still richly valued have booked profits in equity and are using overnight funds to park money and transfer that to equity funds when market valuations turn attractive.

Karkera expects further interest rate increases of 100 -120 basis points in the current financial year. The RBI has raised the key policy rate by 90 basis points in the past two months. "If the expected hike is evenly spread across upcoming scheduled monetary policy meets, investors could earn an annualised return in the range of 5% to 5.5%," said Karkera.

Within the fixed income space, many investors prefer overnight funds as there could be a mark to market loss in the case of long duration or gilt funds. In the past one year, investors have made 1.67% in corporate bond funds and 0.04% in gilt funds.