Money Market Mutual Funds Or Liquid Funds In India-vrk100-an Introduction-24112009

MONEY MARKET MUTUAL FUNDS or LIQUID MUTUAL FUNDS - AN INTRODUCTION Rama Krishna Vadlamudi

BOMBAY

November 24th, 2009

Money Market Mutual Funds primarily invest in money market mutual fund instruments, such as, commercial papers, CBLO, certificates of deposit, treasury bills and call money market for a shorter duration. They invest in securities that are easily convertible into cash. MMMFs are governed by SEBI and are popularly known as liquid mutual funds in India. The salient features of an MMMF are: • • • • • • • • •

• •

It is an open-ended mutual fund scheme meaning one can enter at any time and money can be withdrawn at any time Provides high liquidity along with current income Highly liquid meaning it can be redeemed at a very short notice Minimum investment can be as low as Rs.5,000/Some schemes offer bank type convenience - can invest or withdraw any day (subject to certain rules) Some funds offer withdrawal by cheque (as per applicable rules) Invests in high-quality money market instruments (mostly P1+ or AAA+ rated) Investments are subject to market risks and the net asset value of an MMMF may fluctuate depending on factors affecting the Money Markets Investments in money market instruments are subject to default risk and interest rate risk. Interest rate risk results from changes in demand and supply for money and other macro economic factors and creates price changes in the value of debt instruments. (During the liquidity crisis of September-December 2008, a few liquid and liquid plus funds – not only in India but also in the US – had suffered some losses due to default risk) However, from a practical perspective, the above risks from liquid funds are almost NIL as long as the market regulators do their job well Investments in money market instruments are subject to reinvestment risks as interest rates prevailing on interest or maturity due dates may differ from the original coupon of the bond, which might result in the proceeds being invested at a lower rate

Rama Krishna Vadlamudi, BOMBAY. www.pdfcoke.com/vrk100. Nov. 24th, 2009 Page 1 of 6

MONEY MARKET INSTRUMENTS: They include commercial papers, commercial bills, treasury bills, call or notice money, certificates of deposit, usance bills, CBLO (collateralized borrowing and lending obligation of the CCIL), repos / reverse repos, structured obligation, debentures and any other like instruments as specified by the Reserve Bank of India and SEBI from time to time including MIBOR-linked securities, short-term bank fixed deposits and call products.

SEBI’s NEW RULE: The ‘liquid fund schemes and plans’ shall, with effect from May 01, 2009, make investment in /purchase debt and money market securities with maturity of up to 91 days only, according to a new rule by SEBI.

GENERAL POINTS: •

• • • • • •

•

Liquid mutual fund schemes give much better returns (post-tax) as compared to other shorter-term bank fixed deposits or savings bank (SB) accounts for investors in higher tax brackets Mutual Funds in India manage about Rs 1.04 lakh crore under liquid funds category (as of October 31, 2009) For investing in liquid schemes, no demat account is required You can invest in a liquid fund through any Mutual Fund office or other distributors; like, banks, etc There is no entry load on these funds and there is no exit load also Investment in liquid mutual fund is easy and convenient. Investors have to fulfill KYC (know your customer) norms. Investors can withdraw their money at any point of time. It will take two or three days to withdraw money as the application for withdrawal will take a few days to process There are several well-known liquid mutual fund schemes, like, HDFC Cash Management Savings Plan, Templeton India Money Market Account (TIMMA is the first MMMF in India), Birla Sun Life Cash Manager, SBI Magnum InstaCash, LIC MF Liquid fund, Quantum Liquid fund, DWS Insta Cash Plus Regular, Canara Robeco Liquid Retail fund and UTI Money Market Mutual Fund.

LIQUID FUND RETURNS AS ON NOV. 23, 2009 CAGR LIQUID FUNDS CATEGORY source: ValueResearch

1-week %

1-month %

3-month %

6-month %

1-year %

3.12

3.36

3.36

3.66

4.92

Return % are annualized

NOTE: The returns from liquid funds have fallen in the last six months (after SEBI’s new rule mentioned above) as they cannot invest in instruments with maturity above 91 days and due to high liquidity in the banking system. However, in the next three months, the annualized returns may improve to four or five per cent depending on the interest rate cycle. Rama Krishna Vadlamudi, BOMBAY. www.pdfcoke.com/vrk100. Nov. 24th, 2009 Page 2 of 6

Difference between Liquid funds and Money Market Mutual Funds (MMMFs) (NOTE: As far as mutual funds in India are concerned, the important provisions for MF regulation are contained in: 1. SEBI ACT OF 1992; 2. SEBI (MUTUAL FUNDS) REGULATIONS, 1996; and 3. Various circulars issued by SEBI from to time.)

MONEY MARKET MUTUAL FUND: SEBI (MUTUAL FUNDS) REGULATIONS 1996, define the terms, ‘money market instruments’ and ‘money market mutual funds.’ As per clause 2 (o) of these regulations, the term “money market instruments” includes commercial papers, commercial bills, treasury bills, Government securities having an unexpired maturity of up to one year, call or notice money, CBLO (collateralized borrowing and lending obligation of the CCIL), certificate of deposit, usance bills, and any other like instruments as specified by the Reserve Bank of India from time to time; As per clause (p), “money market mutual fund” means a scheme of a mutual fund which has been set up with the objective of investing exclusively in money market instruments.

LIQUID FUND: The term, ‘liquid’ fund was first defined by SEBI in its circular dated 11.10.2006. And subsequently, the term ‘liquid’ fund’s definition has been amended vide SEBI circular dated 19.01.2009 amending, inter alia, the nomenclature of liquid and liquid plus schemes. In terms of the above two circulars, the main characteristic of a LIQUID FUND SCHEME is that the scheme has to compulsorily invest in debt and money market instruments with maturity of up to 91 days only. (It is inferred that if any scheme invests in debt and money market instruments of maturity of more than 91 days, it cannot be considered as a liquid fund/scheme.) My take on the difference between liquid funds and money market mutual funds:
Liquid fund scheme can invest in debt and money market instruments of a maturity of not more than 91 days. Whereas, an MMMF can invest in money market instruments (as per definition mentioned above) of maturity of less than or equal to 91 days or money market instruments with maturity of more than 91 days also (as per definition mentioned above); but up to one year only

Rama Krishna Vadlamudi, BOMBAY. www.pdfcoke.com/vrk100. Nov. 24th, 2009 Page 3 of 6


While liquid fund scheme can invest in debt as well as money market instruments; an MMMF cannot invest in any instrument other than money market instruments (as defined above). For an MMMF, the money market instrument can have a maturity of more than 91 days also, but up to one year as defined above. As one must have observed, there’s an overlap in the definitions of liquid and MMMF schemes and this is creating confusion among the minds of investors. I hope the above clarification clears the air.

Tax Treatment of Growth Plans of Liquid funds for Resident Individuals 1. LONG-TERM CAPITAL GAINS TAX (LTCG): Suppose a resident individual has invested money in the growth plan of a liquid MF scheme. If she keeps the units for more than a year, the profit from the sale of such units will be subject to long-term capital gains tax at the rate of 20 per cent (including education cess, it comes to 20.60 per cent) with indexation benefit. Without indexation benefit, the tax liability will be 10.30 per cent including education cess. 2. SHORT-TERM CAPITAL GAINS TAX (STCG): Suppose a resident individual has invested money in the growth plan of a liquid MF scheme and she sells the units within one year from the date of investment. The profit from sale of such units will be included in her taxable income and taxed according to her individual tax slab (that is, marginal rate of tax).

Tax Treatment of Dividend Plans of Liquid funds for Resident Individuals

Returns received from dividend plans of liquid MFs are tax-free in the hands of resident individuals; however, mutual funds deduct a dividend distribution tax (DDT) of 25 per cent (including three per cent education cess, it works out to 25.75 per cent) and pays the remaining dividend to the unitholders. To that extent, the return from dividend plans will be lesser.

Rama Krishna Vadlamudi, BOMBAY. www.pdfcoke.com/vrk100. Nov. 24th, 2009 Page 4 of 6

Tax Treatment of Mutual Funds in India

LONG-TERM CAPITAL GAINS TAX *

SHORT-TERM CAP. GAINS TAX *

INIDIVIDUAL

CORPORATE

INIDIVIDUAL

CORPORATE

NIL

NIL

15.45%

16.995%

10.30% without indexation 20.60% with indexation

11.33% without indexation 22.66% with indexation

Taxable as per the rate applicable to the investor

33.99%

Equity MFs

Debt MFs #

* Individual - includes education cess of 3% * Corporate - incl. surcharge 10% and edu. Cess of 3% # Debt MFs include liquid and money market mutual funds

DIVIDEND DISTRIBUTION TAX (DDT) *

Equity MFs

Debt MFs excl. liquid funds Liquid MFs or MMMFs

INIDIVIDUAL

CORPORATE

NIL

NIL

12.875%

22.66%

25.75%

28.325%

As per Section 115R of the IT Act, DDT is payable by debt mutual funds including liquid funds or money market mutal funds (MMMFs) on dividends distributed by them to unitholders. * For individuals, DDT includes education cess of 3% and for corporates, DDT includes surcharge of 10% and education cess of 3%.

For my write-up on GOOD LIQUID MUTUAL FUNDS dated November 24th, 2009, just click: http://www.pdfcoke.com/vrk100 OR http://groups.google.co.in/group/random-thoughts-on-investments/files?hl=en&&sort=date

Rama Krishna Vadlamudi, BOMBAY. www.pdfcoke.com/vrk100. Nov. 24th, 2009 Page 5 of 6

THE BEST OF MY STUFF ON

Reads

http://www.pdfcoke.com/vrk100

1. 2. 3. 4. 5. 6.

Income Tax Slabs 2009-10 for Salaried Class Goods and Services Tax-GST-an introduction Direct Taxes Code Bill 2009-analysis Public Provident Fund PPF ac-Little Known Facts Interest Rate Futures-NSE launches IRFs Nifty Bees-Exchange Traded Fund

2 511 1 609 1 225 1 138 730 633

TOTAL READS already crossed 18,000! From A Total of 61 Documents in just 12 weeks

Rama Krishna Vadlamudi, BOMBAY. www.pdfcoke.com/vrk100. Nov. 24th, 2009 Page 6 of 6