Prime Q&A: Which funds give better return for my emergency fund? …And other questions!

Share on whatsapp
Share via Whatsapp
Share on twitter
Tweet it out
Share on facebook
Share on FB
Share on linkedin
Post on LinkedIn

In this Q&A article, we’ll cover two questions – no, they are not related. Just that they are interesting questions and which you may relate to. Like the first question, which is on where to invest for your emergency fund, given that liquid fund returns (the usual go-to) are dwindling.

On emergency funds

Q We’ve received several questions from you on emergency funds in general. But of late, questions on this topic now ask other fund options that can give high returns as liquid fund returns are low. Some of you have also asked us which other categories you can use for SWPs as returns are low.

A. The need to be alternatives appears to stem from sliding returns of liquid funds, coming off high returns. 3-month returns for liquid funds have slipped below 1% now. 1-year returns have dropped down to 5%. For 2018, 1-year returns averaged 6.98% while it stood at 7.3% on an average in 2019.

With interest rates trending south, obviously, returns for liquid funds are going to reflect the change more quickly than other fund categories. Banks themselves have significantly slashed fixed deposit rates. The question is – should you maintain your emergency fund portfolio in other avenues, in order to eke out better returns?

An emergency fund portfolio needs to have the following characteristics:

  1. It needs to be very liquid.
  2. It needs to be safe from losses and fluctuations in returns as you need to tap into this amount when your normal financial circumstances go awry. You cannot risk that the value of this corpus depletes because returns are volatile.
  3. It needs to be short-term. This is derived from the point above. Long-term investments typically involve volatility and may underperform in short-term periods. Since you do not know when you need to tap into your emergency money, you cannot take on risks of underperformance.

This means you need debt. Specifically, very short-term debt with no risks or volatility. This limits the range of options available. The table below shows how the different debt fund categories stack up on deviation and volatility in returns on a 1-year basis and loss probabilities in 1-month periods.

The above table is not to suggest that you will get at least 5.15% in liquid funds. It could go below that as well. For example, if you try and annualise the current low rate of 0.95% in 3 months (absolute), it comes to a measly 3.8% per annum. That cannot be ruled out if current low rate scenario continues.

What we are trying to showcase through this table is the ability of liquid funds to avoid losses and generate more predictable returns than all other categories.

Liquid funds are also more predictable of the lot, as they necessarily need to invest in papers with a 91-day maturity. Their portfolio is predictable in that they will simply hold short-term instruments. These funds take no credit risk. This combination of high safety, low volatility, and stable strategy is hard to find in other debt fund categories. More, SEBI rules in this category have tightened to reduce risks still further. Do note, here, that falling returns in liquid funds because of a low-rate scenario does not translate into a fund underperforming.

combo

However, you can turn to other fund categories in addition to liquid funds in your emergency fund portfolio. This will help your portfolio generate better returns without compromising much on the risk or volatility front.

These are ultra short-term, low duration, money market, and floating rate funds. These are also funds with low average maturities. They primarily invest in commercial paper, bank certificate of deposits, and treasury bills. The low maturity and the nature of instruments does limit volatility.

Go for funds with low credit risk, and review the funds once a while to check that they are still suitable.

But before jumping on to these funds, note the following:

  1. Low maturity does not mean low risk. Credit risk is the one you know very well. Many funds in these categories do invest in papers with low rating. While CPs and CD holdings are usually of the top credit grade, funds in the ultra short and low duration space often go for short-term bonds (or bonds with short residual maturities) of companies which have low credit rating.
  2. Strategy can change. A fund that was previously high-quality only may change portfolios to take on riskier papers to prop up returns in a falling rate cycle. A fund that currently holds treasury bills and CDs may move to short-term bonds later if more attractive rates are to be found. This can induce volatility in near-term returns.

Therefore,one, go for funds with no credit risk. Two, in your annual portfolio review, check that these funds remain low-risk. If the fund’s nature has changed, switch into a suitable fund. Three, do not allow such funds to form the entirety of your emergency fund portfolio.

You can pick from our recommended list of funds – Prime Funds in the 3 months – 1.5 years’ time bucket for such funds. Make some allocations to them along with liquid funds and fixed deposits. You can use our readymade emergency fund portfolio or take cues from it.

We have a more detailed explanation of how much your emergency fund should be and what should make up an emergency portfolio here. Remember, in an emergency fund, high returns is not what takes importance.

The same holds true, to a large extent, about funds suitable for SWPs. Here, you do need to look for better returns, but safety still takes precedence. For immediate SWP needs, liquid funds continue to remain the best option despite low returns, followed by the very short-term funds as explained above. Funds from other categories need a longer timeframe before you can start SWPs; you can find a detailed explanation on where to invest for SWPs here.

On the hold calls in review

Q The buy/sell/hold calls we give on funds in our MF Review tool throw up an array of questions. One among those is why you should ‘hold’a fund (with a hold call) at all and why you can’t simply sell it outright and reinvest in a ‘buy’ fund.

A. In succinct terms – this will lead to unnecessary portfolio churn and tax outgo, quite apart from resulting in chasing returns. To explain, a fund moves to a hold because there is some slip in performance. There are a range of reasons for this, including but not limited to:

  • Change in fund strategy, where the fund manager is overhauling the portfolio and refining the stock selection process.
  • The fund has seen a few calls go wrong which is pulling down the portfolio returns.
  • The strategy is such that it goes through periods of underperformance only to bounce back later. This is true of value-based and momentum-based strategies.

All this requires a wait-and-watch approach to see if fund performance revives or continues to flounder.

A fund that is otherwise good, that is now underperforming, can well pick up later down the line.

Take the first point. UTI Equity was an underperformer, and then underwent a strategy change in 2016. It remained a mid-range performer until 2018, when it picked up and is now among the better funds in the multi-cap space.

Consider point 2 above. When funds get a few calls wrong and it hurts their return, it will take time for them to reset their portfolios and recoup the performance slide. As long as the fund is trying to turn around, there is no reason to exit. A good example here is Axis Bluechip. This fund was initially among the best large-cap funds, but slipped in 2016 and 2017. As you now know, it is ranking at the top in the large-cap category steadily.

What we’re trying to say is this: a fund that is going through a phase of poor returns does not automatically make it a sell. It requires understanding of the reason for the performance and looking at changing trends in returns. A fund that is otherwise good, that is now underperforming, can well pick up later down the line.

Therefore, there is no real reason for you to sell such a fund: one, it can continue to deliver for your portfolio. Two, improving performance means that you can restart investments in the fund which helps keep your portfolio compact. Three, it will prevent you from selling when returns are not optimal and pay up capital gains tax. Four, it will help you avoid chasing after funds with high returns, as you are likely to do by exiting as soon as performance dips.

When we give hold calls on funds, it is because we are seeing a slip in performance due to various factors. Two, it could be because a poor performing fund is beginning to improve – say, for example, it is moving from a 1.5 star to a 2.5 star and recent performance is showing an uptick. Both mean that waiting it out could see improved returns.

buy hold sell
Share on whatsapp
Share via Whatsapp
Share on twitter
Tweet it out
Share on facebook
Share on FB
Share on linkedin
Post on LinkedIn

Please note that any specific queries on any of our recommendations will be answered ONLY through email. If you are a subscriber, please mail contact@primeinvestor.in.  Only general queries or discussions will be answered through the comment section of the blog. For full details, please refer to this post – How to communicate with PrimeInvestor.

2 thoughts on “Prime Q&A: Which funds give better return for my emergency fund? …And other questions!”

  1. Kishan Magatapalli

    Dear Madam
    I have a query in continuation with the “Hold” or “Buy” question.
    If I don’t have any issue of Cap gains, or Exit load, then won’t it better that I sell off the Fund in the “hold” category and shift the money to the one in the “buy” category? Should the duration to “hold” the fund be dictated by the taxation or Exit load issues?

    1. Hello Sir, What if the hold improves? And there is a high chance that many of the holds are moving from sell lower level to better level. You will be constantly chasing performance then, as only 5% of our calls are a buy. So at any point, a fund can be a hold. So please be aware of that. Unelss you hold too many funds, there is no need, i our view. Thanks, Vidya

Leave a Comment

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.

Register for FREE!

Gain instant access to more PrimeInvestor articles, researched products, and portfolios

The essence of PrimeInvestor

Register for FREE!

Gain instant access to more PrimeInvestor articles, researched products, and portfolios

Legal Disclaimer : Redwood Research (with brand name PrimeInvestor) is an independent research entity offering research services on personal finance products to customers. We are a SEBI registered Research Analyst (Registration: INH200007478). The content and reports generated by the entity does not constitute or is not intended to constitute an offer to buy or sell, or a solicitation to an offer to buy or sell financial products, units or securities. All content and information is provided on an ‘As Is’ basis by PrimeInvestor. Information herein is believed to be reliable but PrimeInvestor does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. The services rendered by PrimeInvestor are on a best effort basis. PrimeInvestor does not assure or guarantee the user any minimum or fixed returns. PrimeInvestor or any of its officers, directors, partners, employees, agents, subsidiaries, affiliates or business associates will not liable for any losses, cost of damage incurred consequent upon relying on investment information, research opinions or advice or any other material/information whatsoever on the web site, reports, mails or notifications issued by PrimeInvestor or any other agency appointed/authorised by PrimeInvestor. Use of the above-said information is at the user’s own risk. The user must make his own investment decisions based on his specific investment objective and financial position and using such independent advisors as he believes necessary. All intellectual property rights emerging from this website, blog, and investment solutions are and shall remain with PrimeInvestor. All material made available is meant for the user’s personal use and such user shall not resell, copy, or redistribute the newsletter or any part of it, or use it for any commercial purpose. PrimeInvestor, or any of its officers, directors, employees, or subsidiaries have not received any compensation/ benefits whether monetary or in kind, from the AMC, company, government, bank or any other product manufacturer or third party, whose products are the subject of its research or investment information. The performance data quoted represents past performance and does not guarantee future results. Investing in financial products involves risk. Mutual Fund Investments are subject to market risk, read all scheme related documents carefully. As a condition to accessing PrimeInvestor’s content and website, you agree to our Terms and Conditions of Use, available here. This service is not directed for access or use by anyone in a country, especially, USA, Canada or the European Union countries, where such use or access is unlawful or which may subject Redwood Research or its affiliates to any registration or licensing requirement.

• Aditya Birla Mutual Fund • Axis Mutual Fund • Baroda Mutual Fund • BNP Paribas Mutual Fund • BOI AXA Mutual Funds • Canara Robeco Mutual Fund • DSP Mutual Fund • Edelweiss Mutual Fund • Essel Mutual Fund • Franklin Templeton Mutual Fund • HDFC Mutual Fund • HSBC Mutual Fund • ICICI Mutual Fund • IDBI Mutual Fund • IDFC Mutual Fund • IIFL Mutual Fund • Indiabulls Mutual Fund • Invesco Mutual Fund • ITI Mutual Fund • Kotak Mahindra Mutual Fund • L&T Mutual Fund • LIC Mutual Fund • Mahindra Mutual Fund • Mirae Asset Mutual Fund • Motilal Oswal Mutual Fund • Nippon India Mutual Fund • PGIM Mutual Fund • PPFAS Mutual Fund • Principal Mutual Fund • Quant Mutual Fund • Quantum Mutual Fund • Sahara Mutual Fund • SBI Mutual Fund • Shriram Mutual Fund • Sundaram Mutual Fund • Tata Mutual Funds • Taurus Mutual Funds • Union Mutual Funds • UTI Mutual Funds • Yes Mutual Funds

Equity: Large Cap Funds | Mip Cap Funds | Large And Mid Cap Funds | Small Cap Mutual Funds | Contra Mutual Funds | Dividend Yield | Focused Mutual Funds | Find Top Index Funds | Best Sector Funds | Thematic Mutual Fund | Best Value Mutual Funds | Equity Linked Savings Scheme | Tax Saving Funds
Debt: Banking And PSU Funds | Corporate Bond Funds | Credit Risk Funds Mutual Funds | Dynamic Bond Funds | Floating Rate Funds | Gilt Mutual Funds India | Find Top Liquid Funds In India | Long term debt funds | Low Duration Funds Debt Funds | Medium Duration Debt Funds | Medium To Long Duration Funds | Money Market Debt Funds | Overnight Debt Funds | Short Duration Debt Funds | Ultra Short Term Debt Fund
Hybrid: Aggressive Hybrid Funds | Arbitrage Mutual Funds | Balanced Advantage Mutual Funds | Conservative Hybrid Funds | Dynamic Asset Allocation | Equity Saving Funds | Multi Asset Funds | Multi Asset Allocation

Scroll to Top
Login to your account