Overnight funds are open-ended debt funds that invest in overnight securities or assets with a residual maturity of one day. At the start of each business day, the Asset Under Management (AUM) is held in cash; later, the fund manager invests in overnight bonds that mature on the next business day. Fund managers tend to use the cash amount to purchase more bonds overnight, and the cycle continues.

The cut-off timing for applicability of Net Asset Value (NAV) in respect to the purchase of units in India Overnight Fund is  12:30 PM. With respect to the redemption of overnight funds, SEBI (Securities and Exchange Board of India) has revised the timings to 1 PM.

The main aim of overnight funds is to offer investors the option to use their cash reserves in a much better way. The following features make their objectives more achievable:

1. Short investment tenure: The securities that Overnight mutual funds invest mature in a day; this short-term horizon permits investors to utilise their surplus funds better.
2. High liquidity: These mutual funds are known for their high liquidity, which enables investors to redeem their money efficiently and in no time.
3. Low risk: Instant maturity and short-term horizon limit the extent of risk that the investments are exposed to.

It’s important to understand where overnight funds invest and how they generate returns to figure out how they work.

Where do overnight mutual funds invest?

Keeping up with SEBI norms, overnight funds invest in assets such as overnight reverse repos, CBLOs (Collateralized Borrowing and Lending Options), and other debt or money market securities that mature in a day. The portfolio comprising overnight securities is replaced each day with new overnight securities. Overnight funds do not invest in deposits or specific risky debt instruments; this rule targets to limit the risk of default in their bond portfolio.

Source of earning

These funds earn only via interest payments on their debt holdings. There is no potential of earning capital gains as these securities mature in a single day. In fact, returns made on these funds reflect borrowing rates and overnight lending. When the interest rates fall and the short-term liquidity is abundant, overnight rates in the market also decline and vice versa.

Following are the benefits of investing in overnight mutual funds:

1. Ease of liquidity: Overnight funds generally do not have any entry or exit loads, which makes them highly liquid. This means that investors can easily redeem their investments during an emergency without compromising the principal invested.
2. Better use of surplus funds: Overnight funds serve as a valuable investment option for investors who want to utilise their surplus cash reserves to improve their returns at minimum risk. Unlike most traditional savings options with extended tenures, overnight funds permit investors to generate gains in a shorter tenure.
3. Low-risk factor overnight funds are accompanied by a low-risk factor, which makes them ideal for investors with a low-risk appetite. Additionally, it also works in favour of those investors who possess a conservative outlook towards investments.
4. Safety against market volatility The changes in interest rates made by the Reserve Bank of India (RBI) or the changes related to the credit ratings of a borrower have a little-to-negligible impact on overnight mutual funds. Their short investment horizon cushions the investors against certain risks like uncertainty against liquidity, credit risk, , and attempts to prevent them from market volatility.
5. Low cost Overnight mutual funds are low-cost debt mutual funds, primarily because their debt holdings are passively managed. 

6. Safer security While risk cannot be wiped-off completely, with minimum credit risk and almost zero interest rate risk, the risk associated with overnight funds is among the lowest in debt funds. This is because it is highly unlikely for these funds to default on interest payments as they mature in one day. In short, overnight funds are relatively less riskier than liquid funds.

Overnight mutual funds are suitable for risk-averse investors who want to invest their money in a fund but only for a short time. You can consider investing in overnight funds under the following situations:

Individuals with a very short investment tenure: Overnight mutual funds are ideal funds for those with an investment tenure of one week or less as investors can redeem these securities after holding the units even for a day. This flexibility is a big selling point for overnight funds over liquid funds, which now charge an exit load for redemptions made within a week.

Way to route investments in equity funds: Overnight funds are also ideal for those investors who do not want to undergo any risks until they move to equity funds. Later, an investor can use a Systematic Transfer Plan (STP) to route their investments into an equity fund. This ensures successful investment in equity funds over time while ensuring that the corpus is successfully held in an overnight mutual fund.

Overnight funds are akin to a traditional savings options   as the investments can be readily redeemed. Thus, overnight mutual funds tend to offer relatively low returns. However, there is some variation among the overnight funds in the market in terms of returns and expense ratio.

Hence, an investor should carefully analyse the market and choose funds that have shown consistently good performance and cost less. Investment in an overnight fund must be aligned with the investor's investment goals and strategy and shouldn’t merely be a reaction to the latest episode of credit default.

Overnight mutual funds are taxed similar to debt funds. Investors earn capital gains and dividend income from overnight schemes.

Dividends shall be taxable in the hands of the investors on the income-tax slab without a lock-in and the mutual fund will deduct tax at source at applicable tax rates before payouts/re-investment. However, the Investor can claim tax credit  of taxes deducted at source at the time of filing of their annual return

Capital gain refers to the difference between the value at which units were purchased and the value at which units were redeemed. The investment tenure determines the taxation rate on capital gains.

Short-term capital gains (STCG) tax
If an investor stays invested in a debt fund for up to 3 years, capital gains earned are considered as short-term capital gains (STCG). The STCG gains are added to the net income tax return of the investor and are taxed according to their tax slab.

Long-term capital gains (LTCG) tax
If an investor redeems the units of an overnight fund after holding it for more than 3 years, the gains earned are considered as long-term capital gains (LTCG). LTCG gains are taxed at 20% (plus surcharge as applicable plus 4% Health & education cess) with the benefit of indexation. Indexation permits investors to inflate the purchase price using the cost inflation index.

To make the most of your mutual fund investments, you must equip yourself with accurate knowledge about how overnight funds function in different situations.

It would be helpful if you also clear your misconceptions when it comes to the risk-reward aspects of debt mutual funds. This will give you a heads up on what to expect from your investments in overnight mutual funds in India. Make sure to invest in mutual funds after considering your goals, investment horizon, and risk profile.

1. Are overnight funds safe?
   Overnight funds are relatively less riskier among debt funds with near-zero credit risk and zero interest rate risk as it is highly unlikely for securities that mature in one day to default on interest payments.
2. Are overnight mutual fund schemes a good choice for ultra-conservative investors?

Yes. Assuming these securities lend only for a day, the risk is negligible. Thus, ultra-conservative investors can consider overnight mutual fund schemes.

3. What is the minimum investment amount for overnight funds?

The minimum investment amount differs for each fund house. However, most fund houses allow investments as low as Rs1,000.

4. What is SEBI's new circular for overnight funds?

SEBI’s new circular states that overnight funds will not invest in debt securities having credit enhancements (CE rating) and/or structured obligations (SO rating). 

The information given here is neither a complete disclosure of every material fact of Income-tax Act 1961 nor does it constitute tax or legal advice. Investors are requested to review the prospectus carefully and obtain expert professional advice with regard to specific legal, tax and financial implications of the investment/participation in the scheme