Last month, State Bank of India reduced it’s interest rates by 50 basis points to 3.5 per cent for savings deposits of less than Rs one crore. Subsequently, several other public and private sector banks cut their savings deposits rates by 50 basis points.
“This is expected to create an opportunity for liquid mutual funds to tap into retail savings, by providing an avenue for parking surplus liquidity while earning a premium over savings rate,” rating agency ICRA said in a report today.
Corporates, institutional investors and business houses have been deploying surplus funds in low-risk products such as liquid schemes of mutual funds for a short duration in addition to bank deposits, it said.
With the reduction in savings rate, liquid funds, which offer the advantage of liquidity and flexible maturity with easy redemption, are expected to gain prominence as an alternative tool, as retail investors also increase usage of the available benefits of liquid schemes, the report noted.
Liquid schemes have reported annualised returns in the range of 6.5-7 per cent over the last one year. The returns have, however, moderated to 6.25-6.5 per cent over the last five months on the back of declined in repo rate, it said.
These schemes have provided 2.75-3 per cent higher pre-tax returns on an annualised basis than savings accounts.
“However, accounting for income tax benefits associated with interest in savings deposits, the difference between annualised returns of liquid funds and savings accounts moderates to 0.87-1.63 per cent for an individual at the highest tax bracket,” Icra’s senior vice president and group head (financial sector ratings) Karthik Srinivasan, said.
ICRA noted that the growth in the individual investor base for mutual funds had hitherto driven the growth in equity assets under management (AUM), while the individual investors’ interest in the liquid schemes was limited.
The cut in savings rate below four per cent may result in the emergence of liquid mutual funds as a direct alternative to savings deposits and lead to greater individual investor participation in this asset class, the report said.
Though liquid mutual funds, like other mutual funds, are subject to market risk, the shorter maturity profile of the underlying investments of around 1-2 months and the high credit quality of the underlying portfolio, which comprises money market instruments like certificate of deposits, treasury bills, and high rated commercial papers alleviate credit risk to some extent.
“With the arbitrage between liquid mutual funds and bank deposits likely to continue, the pace of incremental inflows into liquid mutual funds is expected to increase over the near to medium term as some part of the surplus funds are moved away from bank deposits as investors look to improve returns without taking too much risk,” Srinivasan added.