Liquid Funds have recovered substantially from their fall on July 16. Remember, on July 15, the RBI took extraordinary measures to cut liquidity and that raised short term interest rates by 300 bps (3%). This caused liquid funds to fall in their NAV, as short term funds were impacted by rising yields (yields move inversely with prices).
At the time there was a fear that these funds have a major problem. However, my view has been that if you don’t need the liquidity, stick around. The NAV will recover, and it has. Here’s the NAVs of all liquid funds since then, and the return from July 15.
(Note: Mirae Asset Liquid Fund is missing, which has reported a positive return till 30 July but the NAV is not available after that)
See carefully that yields on July 15 were just 7.5% for a short term security (CP, CD or govt debt of less than 1 year to maturity). Today these yields are at 10% or whereabouts, and yet, liquid funds have kicked into profit. The funda: for short term assets, the interest accrual on a bond will quickly overshadow the price drop (which is very short due to the small duration).
Yields won’t rise forever – they will find a top at which there will be enough buyers to keep the price steady. The question was – and I suppose, will be going forward – is the 10% the top, or will we see a higher number? This will tell you if you should buy bond funds.
Liquid funds on the other hand should only hurt if there is a potential of default, the risk of which, given the situation wit NSEL, I will not write off.
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