What is an Overnight Fund? Features, Benefits, and Returns Explained

What is an Overnight Fund?

An overnight fund is a type of debt mutual fund that invests in short-term securities with a one-day maturity. These funds lend money to corporations for just one business day, and the securities mature daily. The fund manager reinvests the proceeds into new one-day securities, ensuring liquidity and minimising risk.

Overnight funds primarily invest in safe instruments like repos and reverse repos. Additionally, they don’t face the same risks as long-term debt funds, such as interest rate fluctuations or credit defaults.

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Key Features of Overnight Funds

We have mentioned the key features of overnight mutual funds that you should be familiar with —

Safe Parking for Idle Cash	If you have surplus cash or a large sum of money that you don’t need immediately, parking it in an overnight fund is a great option. This way, your money can earn some interest while remaining highly liquid and safe.
Low Returns, Low Risk	Due to their low-risk profile, overnight funds generally offer lower returns compared to other mutual funds. However, the returns are stable and predictable, making them ideal for risk-averse investors.
High Liquidity	You can redeem your investment anytime without any exit load or penalty. Also, the funds are easily convertible to cash ensuring quick access to your money.
Minimal Interest Rate Impact	Overnight mutual funds are not affected by fluctuations in interest rates as much as other debt funds. They are, however, directly linked to the overnight lending rate, which can change based on market conditions.
Ideal for Short-Term Investment	These funds are perfect for investors with a very short investment horizon, typically less than a week. It’s an ideal choice if you want to invest for a few days to a couple of weeks without worrying about market fluctuations.
Tax Benefits	They enjoy tax advantages similar to debt funds. If held for more than three years, they qualify for long-term capital gains (LTCG) tax benefits, which are taxed at 20% with indexation in India. Short-term gains (if sold before three years) are taxed according to your income tax slab rate.

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How Do Overnight Mutual Funds Work?

To understand how overnight funds work, it’s important to look at the investment strategy and return generation mechanism.

Where Do Overnight Funds Invest?

Overnight mutual funds primarily invest in debt instruments like CBLOs (Collateralised Borrowing and Lending Obligations), overnight reverse repos, and other similar securities.

These investments are typically made with financial institutions, including banks, insurance companies, mutual funds, and NBFCs (Non-Banking Financial Companies) which are considered safe and reliable borrowers. As a result, they offer a stable and low-risk investment option.

How Do They Generate Returns?

Overnight mutual funds earn returns through the interest payments made on the securities they hold. Since the maturity period of these instruments is only one day, overnight funds do not rely on capital appreciation but on interest income. The returns generally reflect the prevailing overnight lending rates in the money market.

If the interest rates rise, overnight rates will also increase, leading to higher returns for investors. Conversely, if rates drop, the returns will fall. Therefore, the returns are tied to short-term interest rate movements and liquidity conditions in the market.

Daily Reinvestment

The fund manager of an overnight fund reinvests the proceeds from maturing securities into new overnight securities each day. This constant reinvestment ensures that the fund stays fully invested and earns returns without exposing the investors to long-term risks.

Who Should Invest in Overnight Funds?

Overnight funds are ideal for —

Investors with a Short-Term Investment Horizon	If you need to park funds for just a few days or weeks, overnight mutual funds are a perfect choice.
Risk-Averse Investors	If you have a low risk appetite but still want to earn returns on your idle cash, these funds offer the ideal blend of safety and returns.
Institutional Investors	Corporates, banks, and insurance companies often use them to park surplus funds temporarily.
Building Emergency Funds	If you want to set aside money for emergencies but still earn some interest, they offer a safe place for such funds.

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Different Overnight Funds Returns

Below table shows the different types of Overnight funds available with their annualised return of 3 years and expense ratio.

Fund Type	3 Yr Annualised Return	Expense Ratio
Axis Overnight Fund Direct Growth	5.98%	0.06%
HSBC Overnight Fund Direct-Growth	5.96%	0.06%
DSP Overnight Fund Direct-Growth	5.96%	0.06%
Mahindra Manulife Overnight Fund Direct - Growth	5.95%	0.09%
PGIM India Overnight Fund Direct-Growth	5.94%	0.1%
Aditya Birla Sun Life Overnight Fund Direct-Growth	5.95%	0.08%
Mirae Asset Overnight Fund Direct-Growth	5.97%	0.07%
Franklin India Overnight Fund Direct - Growth	5.88%	0.1%

Note: The annualised returns of the funds keep on fluctuating. Hence, it’s better to stay updated.

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Taxation on Overnight Funds

Just like other debt funds, overnight mutual funds are subject to taxation. Here’s how they are taxed —

Short-Term Capital Gains (STCG): If you sell your overnight fund before three years, the capital gains are taxed at your applicable income tax slab
Long-Term Capital Gains (LTCG): If held for over three years, overnight funds are subject to LTCG tax at a rate of 20% after indexation.
Indexation adjusts the purchase price to account for inflation which reduces the taxable amount.
Dividend Distribution Tax: If you opt for the dividend option, the dividend distribution tax is 29.12%.

Frequently Asked Questions

Overnight funds offer higher liquidity and better returns than fixed deposits (FDs) in the short term. However, FDs may offer slightly more stability in returns, especially for longer tenures.

Both liquid and overnight funds invest in short-term instruments, but overnight funds focus solely on one-day securities, making them safer and more liquid than liquid funds.

You can withdraw from an overnight fund on any business day, and the withdrawal process is quick and hassle-free.

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