Many business owners look for safe and fixed return ways to manage their surplus funds. One of the simple and safest ways that has gained immense popularity among business owners is overnight funds.

In today’s KOFFi break, we will shed some light on what overnight funds are, how they work, and how it can be the best way for businesses to park their short-term funds.

What are Overnight Funds?

Overnight funds are open-ended debt mutual funds that invest in overnight securities or assets with a maturity of just 1 day. At the start of each day, the Asset Under Management (AUM) Company is held with cash.

The fund manager of the respective AUM invests the cash in overnight bonds that mature on the next day.

Overnight funds offer better liquidity with minimal risk, making it the best choice for business owners who are looking to park their surplus funds for a very short duration.

These funds give an edge to use the cash reserves in a much better way. Overnight funds guarantee that the invested money is returned with low returns in less time. Let’s understand how it gives zero-risk returns.

How Overnight Funds Work

The primary mechanism of overnight funds involves investing funds in debt securities that mature the next day. Let’s take a closer look at how it operates in 3 basic approaches:

• Investment in Debt Instruments: Overnight funds invest in high-quality, short-term debt instruments issued by government and corporate entities. They all have a maturity period of 1 day.
• Daily Maturity and Reinvestment: On a daily basis, the fund manager invests in securities that mature in the next 24 hours. Upon maturity, the principal amount and earned interest are reinvested in new overnight securities.
• Zero-Risk Returns: As overnight funds have an instant maturity span and a very short duration, they are risk-free. The basic risk associated with debt investments is less interest rate(as the funds mature daily).

Let’s understand with a real example:

Imagine you have ₹10,000 cash which you decided to park safely in overnight funds and earn some returns.

Here are the actions performed on Day 1 and Day 2:

Day 1:

• You wish to invest ₹10000 in an overnight fund.
• The fund manager takes your money.
• Fund manager buys the best short-term debt instruments like treasury bills, etc which can mature more on the next day.

Day 2:

• The treasury bill matures.
• The principal and interest are returned. Ex. ₹10000 + ₹100 = ₹10100
• The fund manager reinvests the total amount into new short-term securities to gain more interest.

Daily Operations:

• The Buy-Mature-Reinvest cycle continues on a daily basis to gain more interest.
• The Net Asset Value (NAV) keeps on increasing each day because of the interest gained.

This is how overnight funds work with a zero-risk returns process.

Benefits of Fund Parking in Overnight Funds

• Safety and Security: Overnight funds invest your surplus in high-quality, safe, and secure debt instruments.

• High Liquidity: Investors can redeem their investments in overnight funds at any time, and the funds are usually credited back to the investor’s account on the next working day.
• Lower Expense Ratio: Overnight funds have a lower expense ratio. It means, less amount of the fund’s assets are used for administrative and other operating purposes.

These are some of the highlighted and effective benefits of overnight funds. Look at some of the risks and returns associated with overnight funds.

Risk and Return Associated with Overnight Funds

Overnight funds are considered one of the safest investment options for fund parking but, still explore the associated risks and returns:

• Low Return: Returns are lower compared to other mutual funds. It provides more safety and liquidity compared with high-return funds.
• Credit Risk: Overnight funds have very minimal credit risk because the securities mature within a day. This ensures the principal is returned promptly, minimising default risk and making overnight funds a very safe option for parking idle funds.
• Interest Rate Risk: Practically, the interest rate risk is zero because of the daily maturity of the instruments.

Who Should Use Overnight Funds?

Overnight funds are suitable for:

1. Individuals:
   • Great for individuals who want to invest money for a short time
   • Wishing to earn interest from emergency funds
   • Grow short-term surplus funds
   • Get better and safer returns in the short term
2. Businesses:
   • With a good amount of surplus cash
   • Keeping funds to achieve the upcoming business goal

If you are going ahead to park your funds then, read the below pointers.

Things to keep in mind

Before you move ahead to park your funds in overnight funds, keep these pointers in mind:

• Return Expectations: Your primary goal to invest in overnight funds should be safety and liquidity, not high returns. You can’t expect more and too little from overnight funds.
• Investment Time Period: These funds are utmost suitable for a few days to a few weeks. For a long duration, these funds might not be appropriate. You can invest in some other options if you want to invest for a long time period.
• Credit Quality: Review the credit quality of your fund management company. Ensure that it aligns with your interest returns and risk tolerance.

For a comprehensive guide, check out this blog detailing the 5 key factors to consider when choosing a debt fund.

Conclusion

Overnight funds are a great alternative for businesses that are looking to manage their short-term surplus funds with zero-risk returns. High liquidity, extreme safety, and predictable returns make overnight funds an excellent choice for small to large business owners.

By understanding how overnight funds work and their benefits, you can make a decision to opt for overnight funds.

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