What is overnight fund?

Published On: 27-May-2020

As the name suggests, an overnight fund scheme is a fund that invests in overnight securities having a maturity of one day. Overnight mutual fund schemes are the fifth most popular category amongst the debt funds, after liquid funds, corporate bond fund, short-duration fund, and low duration fund. As of 31st March 2020, overnight funds schemes occupy around 8% share across the overall AUM (Assets Under Management) of open-ended debt schemes with AUM of Rs. 0.80 lakh crores. Source: Association of Mutual Funds in India - AMFI


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Here are the salient features of overnight fund schemes:

Low Credit Risk

Credit risk refers to the risk of the issuing entity defaulting on the servicing obligations of the invested security. Since overnight securities are predominantly CBLO (collateralized borrowing and lending obligation) & sovereign securities such funds carry significantly low credit risk.

Negligible Interest Rate Risk

Interest rate risk refers to the risk of changes in the valuation of the debt securities due to the changes in interest rates. Considering that most of the debt securities carry fixed interest rates, any changes in the market interest rates will make an existing debt security demand premium or discount basis the fixed coupon rate. 

For example, if the interest rates decrease, the existing securities issued at higher interest rates will demand a premium over the face value. This is because such benefit of the higher coupon as against the market interest rates will continue to accrue over the future period. Since the maturity of overnight securities is that of a single day, such funds are immune to interest rate risk.

High Liquidity

The overnight fund schemes tend to stay immune from the liquidity risk as well since they are not dependent upon secondary markets for the liquidity of their investments. Instead, the maturity happens in a single day, and the maturity amount flows directly from the issuer itself. 

No Exit Load

Since overnight fund schemes are offered as an alternative for parking short-term surplus funds, they do not carry any exit load. As such, the investors may invest in overnight fund schemes for any duration, even as low as one day, and still, earn returns for that period. As per the prevailing guidelines, traditional investments like fixed deposits may offer interest only on investment of 7 days or more. 

Mutual Fund Returns

Since such funds are the most conservative funds amongst the debt fund universe, the returns might be relatively lower, albeit with lower risks.

Taxation of Overnight Fund Schemes

As per the prevailing tax laws, the mutual fund investors are taxed at the time of redemption of mutual fund schemes. The appreciation in mutual funds are taxable under the head ‘Income from Capital Gains’. Considering the portfolio of overnight fund schemes, these funds are considered as non-equity oriented mutual funds for tax purposes. 

For such funds, the specified period for bifurcation of gains as Short-Term Capital Gains (STCG) and Long-Term Capital Gains (LTCG) is 36 months. As such, if the investment period of mutual fund units of overnight fund schemes is less than 36 months, the returns are taxed as STCG and taxed at the regular tax rates applicable to the investor. If one has held the units of overnight fund schemes for 36 months or more, the gains are classified as LTCG and taxed at 20% (plus applicable cess and surcharge) with indexation benefit

Note: The tax provisions, as mentioned in the article, are for illustrative purposes only, and are updated as per the Union Budget 2020 passed by the Parliament. The tax rates for capital gains will be as per the tax laws applicable on the date of redemption/ sale and not on the date of investment.