We all use liquid debt funds to park cash for any emergency requirements or for short term requirements.
Liquid funds are a sub class of debt funds and they invest in bonds of the government or other companies. The investee companies promise to return the interest and sum invested.
Some debt mutual funds recently had an impact, as they invested in IL&FS group companies. IL&FS is not able to service its debt and as a result its bonds have fallen in value. Rating agencies which till recently gave it a very high rating (A1+ as recently as August 2018) have now marked it as D.
This rating downgrade of IL&FS was sudden and took all by surprise. Mutual funds had to mark down the value by about half. One such fund is Principal Cash Fund which has been a consistent top performer till recently. IL&FS holdings are approx 10% of this fund.
As a result this fund has incurred two drops in the NAV. The fund has already taken a majority of the hit in its NAV. We estimate that if they were to write off the entire investment in IL&FS, this fund could further fall by 2%.
The fund hasn’t yet sold off the IL&FS paper which means that it will try and recover some part of the holding. LIC is also interested in fixing up things. If there is bail out, your NAV might recover.
Given this we advice our clients to wait some more time and then take a final call.
The takeaways from this episode:
1. Do not seek highest returns in liquid funds. Need here is safety and hence funds that invest in 90 day T-Bills or Short term G-Sec are preferable.
2. Diversify ones holdings even in liquid funds.It is almost impossible to identify risk in one company/fund. Since even rating agencies find it difficult to identify risk 100% accurately, diversification is the best solution for an investor, across and within fund classes.
