When it comes to debt investments, investors are generally inclined to traditional investment products like bank deposits. However, one can also invest in debt funds for investment exposure towards debt securities. Debt funds can be classified into different sub-categories like duration funds, gilt funds, credit opportunities funds, etc., depending upon the broader investment objective and type of debt securities such funds can invest in.
Of such categories, mutual fund schemes investing in money market securities with a maturity of up to one year are categorised as money market funds.
While such funds are one of the mutual fund categories allowed by SEBI, a broader classification may comprise the following types of funds investing in money market instruments:
1. Overnight Funds – Investing in overnight securities with a maturity of one business day.
2. Liquid Funds – Investing in securities with a maturity of up to 91 days.
3. Money Market Funds – Investing in money market instruments with a maturity of up to one year.
While there are some other mutual fund categories with lower duration, the determining factor for such classification for those funds is Macaulay Duration, which may also vary due to the interest rate reset or put/call options in the invested securities. However, the above three types of money market mutual funds categorically invest in securities with shorter maturities only.
Major Money Market Instruments
One common feature amongst money market instruments is that such securities are issued at a discount to the face value. Such a discount represents the implied interest cost for such securities. Money market funds may invest in the following types of money market instruments:
Treasury Bills (T-Bills)
Such securities are Sovereign securities and are considered risk-free investments. Such securities may be issued for 91 days, 182 days, and 364 days.
Certificate of Deposits (CDs)
Financial institutions like banks issue a Certificate of Deposit or CD for the short-term.
Commercial Papers (CPs)
Commercial Papers are instruments issued by Corporates to bridge their short-term funding requirements. To aid the liquidity of such instruments, these are generally listed on stock exchanges.
Repurchase Agreements (Repo)
Repurchase Agreements, also known as Repo/ Reverse Repo operations, are carried out between the authorized parties and are undertaken with the help of underlying securities like treasury bills, central or state government securities, corporate bonds, and PSU bonds.
Benefits of Money Market Funds
One of the primary advantages of the call money market is that it is tightly regulated by the Reserve Bank of India (RBI), and issuances are primarily from sovereign entities or regulated/high-rated entities. This helps to mitigate the credit risk for the scheme.
Further, with the maximum maturity of money market instruments being not more than one year, the impact of interest rate changes on portfolio valuation and consequential interest rate risk is lower. Money market funds can help investors aim to generate reasonable returns with relatively low investment risk with money market funds.
Taxation of Money Market Funds
The gains from money market funds must be classified as Short-Term Capital Gains (STCG) and Long- Term Capital Gains (LTCG) based on the holding period by the investors. If the investors have held such mutual fund units for less than 36 months, the gains are taxed as STCG at the regular tax rates applicable to the investor. If the holding period is 36 months or more, the gains are taxed as LTCG with a tax rate of 20%.
Disclaimer:
The tax provisions mentioned in the article are for illustrative purposes only and updated as per the Union Budget presented in the Parliament in February 2024. The tax rates for capital gains will be as per the tax laws applicable on the date of redemption/ sale.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.