You may sometimes find yourself with surplus money that you plan to use soon. For example, you might wait to invest in equities, pay for a large purchase, or move money into another investment in a few days. Keeping this money idle in a savings account may feel safe, but it often generates nominal returns. At the same time, you may not wish to take market risks with such short-term funds.
In situations like these, overnight funds offer a practical solution. These funds are designed for parking money over very short periods while maintaining high liquidity and relatively low risk. To understand their usefulness better, let’s look at what overnight funds are, how they work, and their benefits.
Understanding overnight funds
Overnight funds are open-ended debt schemes that invest in highly safe debt and money market instruments. According to the Securities and Exchange Board of India (SEBI) guidelines, these funds must only purchase securities that mature within one day. Because the underlying assets have such a brief lifespan, the overnight fund undergoes a daily reset.
Entities eligible to borrow through this route operate under regulatory supervision. These entities mainly include banks, insurance companies, provident funds, mutual funds, and NBFCs.
Where do overnight funds invest?
Overnight funds place their money in Collateralised Borrowing and Lending Obligations (CBLOs), overnight reverse repos, and various other debt or money market instruments that mature within a day. SEBI regulations require these funds to hold only securities with overnight maturity. Because of this rule, the assets of an overnight fund fall under the category of cash and cash equivalents. The fund manager renews the portfolio every day with fresh overnight securities.
Regulations also prevent overnight schemes from investing in deposits or certain high-risk fixed-income mutual funds in order to lower the possibility of default within the bond portfolio.
What drives returns in overnight funds?
Overnight funds generate income from the interest on the debt instruments they hold. The fund can rarely earn capital gains because the securities mature within one day. The returns of overnight funds, therefore, mirror overnight lending and borrowing rates. When interest rates fall, and short-term liquidity in the market remains high, overnight money market rates decline. When interest rates rise and liquidity becomes tight, overnight rates move upward.
As a result, the returns of overnight funds depend closely on the rates and liquidity conditions in the overnight money market.
Who should invest in overnight funds?
Overnight funds are ideal for those with an investment horizon of one week or less, as you can redeem after holding the units for even one day. This flexibility is a big benefit of overnight funds over liquid funds, which now charge an exit load for redemptions within 7 days.
If you want to move money into equity funds but prefer not to take market risk immediately, you can park your funds in an overnight fund first. From there, you can set up a Systematic Transfer Plan (STP) to gradually shift the investment into an equity fund over time. This approach lets you enter equities in phases while keeping the money in a relatively low-risk option until it is deployed.
To sum up
Overnight funds provide a reliable option for managing surplus money over very short periods. Their one-day maturity helps keep risk extremely low while allowing quick access to funds whenever you need them. Although the return potential remains modest, the combination of safety and liquidity makes them a practical tool for short-term cash management.
If you prioritise capital protection and easy withdrawals, overnight funds can serve as a convenient place to hold money until it is needed or allocated to other investments.
