In the past few years, liquid funds have witnessed huge losses – something that was considered impossible. So it’s very important to tread with caution. Before, we ponder on how to select the best liquid funds while minimizing credit risk, let’s understand what liquid fund is.Liquid funds are a variant of debt funds – a type of mutual fund that invests in securities with maturity up to 90 days. This means that the possibility of Net Asset Value (NAV) reacting severely to interest rate movements is significantly small. Unlike other mutual fund investments, liquid funds can be used to simply park money as opposed to investing or even saving.
Ways to select the best liquid funds for investments:
- Go for liquid mutual funds with high AUM
Though liquid funds carry limited interest rate risk, they are exposed to credit risk. In a situation where one of the securities in the portfolio are bound to default, the one with higher exposure or larger Asset Under Management (AUM) is likely to take the fall. Go for a liquid fundthat has an AUM of atleast Rs10,000 crores or more. - Go with bigger fund houses
Usualiquidly, bigger fund houses have a better reputation to manage. They may also provide an exit to investors at trivial loss. Additionally, smaller funds have the reputation take higher risk to gain better returns. On the other hand, bigger funds tend to have almost no credit risk. - Choose a fund with low expense ratio
Expense ratio is one of the most important criteria for evaluating the perfect liquid fund for you. Sure, in case of equity mutual funds, expense ratio is not even considered as a criterion. However, since liquid funds have substantially low returns, so higher expense ratio would mean less returns.
The ideal liquid fund for your investments would be the one that uses only Government bonds (gilt).
