Bank FDs in spotlight as returns of liquid funds hit two-decade low

1-year returns down to less than 3.5%, below short-term rates offered by banks on FDs

Returns on liquid funds have slumped over the past few months, with 1-year returns now at 3.4 per cent — among the lowest in the past two decades — and below the short-term interest rates offered by several banks on fixed deposits.
 
This will especially hurt institutional investors, who contribute an estimated 80 per cent to assets of such funds.
 
There is excess liquidity in the system following the supportive action by the Reserve Bank of India (RBI), with reverse repo rates at 3.35 per cent, and this is being reflected in the returns of liquid funds, said experts. 
 
“Returns are likely to remain at current levels as it is clear that the RBI is in no mood to increase rates. There is surplus liquidity and there is no credit pick-up, and I do not think money market yields will go up sharply in the next few months,” said Mahendra Jajoo, Chief Investment Officer (fixed income) at Mirae Asset AMC.
 
Corporates, however, have continued to park surplus cash in liquid funds as the ample liquidity offered by such funds takes precedence over absolute returns.
 
“The rates offered by liquid funds are still very competitive, especially when compared to fixed deposit rates of one month and below. Additionally, banks may offer lower rates for deposits of Rs 2 crore and above, and typically levy a penalty for premature closure. Liquid funds allow you to withdraw money on any day at the rates applicable after seven days (before which an exit load is levied). So, net-net, liquid fund returns may still be better than bank FD rates,” said Sunil Subramaniam, managing director and CEO of Sundaram MF.

 
Amol Joshi, founder of Plan Rupee Investment Services, says liquid funds have traditionally not been sold as returns-oriented products, and financial advisors typically advocate them for two reasons. The first is to park emergency corpus or to meet very short-term money needs such as payment of school fees due in six months. The second is for parking surplus corpus that can then be transferred to the desired equity fund via a systematic transfer plan.
 
“Investors that invested in liquid funds for liquidity and wanted returns too will have to sacrifice on the latter. Institutions will have to bear the impact as there are hardly any comparable options,” Joshi said.
 
According to Subramaniam, corporates do shop around for the best interest rates with different banks, and may park some incremental money with banks going forward if the rates are higher than those offered by liquid funds.
 
“If a bank is desperate for short-term money because of an asset liability mismatch, it may pay higher rates for 15-day or 30-day deposits. Having said that, corporate treasuries do assess the pedigree of banks and may be wary of putting money in some names even if they offer higher rates,” he said.
 
“Investors with an investment horizon of less than six months could look at parking their money in savings accounts of banks such as IDFC First Bank, Bandhan Bank, or AU Small Finance Bank. This is because if it is a savings account, they can withdraw the money whenever they want. Arbitrage funds may also end up generating better post-tax returns than liquid funds, given the current spreads are decent and taxation is more favourable,” said Kirtan Shah, a financial planner.
 
IDFC First offers 6 per cent per annum on savings account balances equal to or less than Rs 1 crore, and 5 per cent on amounts above Rs 1 crore and less than or equal to Rs 10 crore. Bandhan offers 6 per cent on balance ranging from Rs 1 lakh to Rs 10 crore, 6.55 per cent on Rs 10-50 crore, and 7.15 per cent on balance above Rs 50 crore. AU SFB offers 7 per cent on balance of Rs 10 lakh to less than Rs 5 crore.
 
“Some money at the margin may shift to bank FDs or other debt categories such as ultra short-term, low-duration, and money market funds,” said Joydeep Sen, corporate trainer, author, and columnist.
 
Those with a 3-6-month horizon may look at ultra short-term funds, and those with a 6-month to a one-year horizon can look at low duration or money market funds, he said.
 
In the last one and half years, individual investors with longer horizons have parked money in categories such as banking and PSU funds, corporate bond funds, and short-term debt funds.