If you scroll through any mutual fund website, and you will find a lot of data about how a particular fund or scheme of the AMC has outperformed the market. There could be an analysis of how the particular fund has beaten the market index. There could also be a comparison between a particular fund and the other funds in the category to highlight the superiority of a particular fund. There could be an elegant table or chart which outlines how that particular fund could have created wealth for an investor over a period of time. As a smart investor, it is your job to conduct 6 basic tests before deciding on buying a mutual fund.
- Redemption when and where you want
- Redemption with less volatility risk
- Matching maturity with requirement
- Liquidity through collateral offer
Topics Covered
Redemption when and where you want
The process of redeeming your funds has been made quite simple. One only needs to give a redemption request and the funds are credited to the bank account of the beneficiary within 2 days at the prevailing NAV on the date of redemption. This access to funds at short notice makes mutual funds especially attractive from a liquidity perspective. Today, most of the large mutual fund houses offer the facility of online redemption. This is a lot simpler. There is a one-time registration required wherein the investor is allocated a secret PIN code through physical mail. With this PIN, the redemption is done online and the funds are directly credited to the beneficiary bank account. It normally takes 2-3 working days to get the funds credit which still makes mutual funds very critical from a liquidity perspective. This is in the case of equity funds and FOFs. In case of debt and liquid funds, the redemption proceeds are actually credited within one day, which makes it all the more liquid.
Redemption with less volatility risk
This is where mutual funds score over equities. If you are holding on to equity shares then they can lose value in a short span of time. However, since mutual fund schemes are spread across a number of equity shares, they are diversified and hence the risk of volatility is not too high. Even if one of the stocks in the portfolio cracks during the day, the impact on the NAV will not be too high. Hence based on the previous day’s NAV, the investor can get an approximate idea of how much liquidity will be available. This is a big advantage that mutual funds possess over direct equities and is a direct outcome of the diversification benefit of mutual funds. Of course, in the case of debt funds, the volatility is normally an outcome of interest rate expectations and liquidity constraints. But even in that case, the impact on the overall NAV is quite limited.
Matching maturity with requirement
This is another big advantage that mutual funds offer and is critical to ensure that liquidity is available as and when you require without compromising on your returns. The Monthly Income Plans (MIPs) are closed ended funds that can have a maturity tenure that exactly matches with your needs. This ensures that the need for liquidity matching is automatically taken care of. The mutual funds also offer dedicated schemes for planning long term needs like education of children, retirement planning etc. Here the fund automatically allocates increasingly towards debt as the term to maturity of your requirement nears so that liquidity can be ensured without any substantial loss in capital value.
Liquidity through collateral offer
There is another interesting way through which mutual funds offer liquidity and that is by offering the MF units as collateral. Equity funds enable you to get funding to the tune of 50% of the value of the fund but in case of debt funds you can actually get a much higher funding ratio as the risk is lower. Additionally, your mutual fund units can also be offered as collateral for a variety of payments. In case of groups that have mutual fund and banking arms, the entire process of offering and availing loan against mutual fund units becomes seamless and online. This also makes the process of liquidity through collateral much simpler.
Recommended Read: How Mutual Funds Help Investors Manage Their Risk Better?
In a nutshell, mutual funds can largely help you meet your liquidity requirements. It is not only about easy liquidity but also about ensuring that the core value of your investment is not lost. But more importantly, through mutual funds you can match the availability of liquidity to your long term needs, which is normally not possible with other asset classes. And, you cannot forget that you can also use your mutual fund units as collateral for availing funding. That surely makes them a lot more liquid than we can imagine.
