Overnight Funds: Meaning, Benefits, Taxability, Who Should Invest

Manish Kothari
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Manish Kothari

What are Overnight Funds?

Overnight Fund is a new category of debt mutual funds that was introduced in 2018 under the SEBI's reclassification of mutual funds. As per SEBI, Overnight funds are open-ended debt schemes which predominantly invest in overnight securities with a maturity of one day.

How do they work?

Overnight funds invest in Collateralized Borrowing & Lending Obligations (CBLOs), overnight reverse repos, and other debt & money market securities that have a maturity of one day. As per SEBI regulations, these funds are not allowed to invest in any risky securities with maturities of more than one day. Investing in only high-quality overnight securities reduces the risks of default in these funds. This is why overnight funds are considered to be one of the safest categories in debt mutual funds.

The portfolio of overnight funds is updated every day with the new securities. At the start of each business day, all of the fund's assets are in the form of cash. During the day, the fund manager will buy securities maturing overnight. As the old securities will expire, the fund manager will then make fresh investments in new securities the next business day. 

As the maturity of underlying securities in overnight funds is just one day, there is no scope for generating capital gains on investments. Therefore, the returns on overnight funds are based on the interest income earned from their underlying securities.

Benefits of investing in Overnight Funds

  • High Safety

Overnight funds are considered one of the safest funds in the debt mutual fund category. The very short maturity of one day in overnight funds reduces the overall risks in the portfolio. These funds have very low or almost negligible credit & interest rate risks.

  • Low Expense Ratio

The expense ratio of overnight funds is very low compared to other debt mutual fund categories as the portfolio is not actively managed. The low-cost structure offers higher returns post expenses. 

Currently, the expense ratio of overnight funds is in the range of 0.05%-0.26% of total assets.

  • No Exit load

Another reason to consider overnight funds is that these funds do not charge any exit load on redemptions. Redemptions can be made anytime as per the requirements of the investor without any costs.

  • Ideal for Short-term investments

The overnight fund invests in securities with a very short maturity of one day. This makes it suitable for investments in these funds for an investment horizon of a week or less. Since liquid funds charge exit loads on redemptions made before 7 days, overnight funds are a preferred mode of investment.

Corporates or businesses could park their idle money lying in their current account in overnight funds for earning extra returns.

  • High Liquidity

Overnight funds are considered a very liquid form of investment. These funds offer high liquidity & safety just like a savings bank account along with the scope of better returns.

Taxability of Overnight Funds

As overnight funds invest in debt securities, they have the taxability of debt mutual funds. Following taxation is applicable:

  • Short-Term Capital Gains (STCG) Tax

If the units of overnight funds are held for less than 3 years, then the gains on investment are treated as Short Term Capital Gains. STCGs are taxable as per the income tax slab rate applicable to the investor.

  • Long-Term Capital Gains (STCG) Tax

If the units of overnight funds are held for more than 3 years, then the gains on investment are treated as Long Term Capital Gains. LTCGs are taxed at the rate of 20% after indexation benefits.

Note: Gains on investments are taxable only if the units are redeemed by investors. Otherwise, no tax is applicable on unrealized gains.

Who should invest in Overnight Funds?

  • Corporates

Overnight funds are mostly recommended for corporates, institutions & businesses to park their surplus or idle money which they might need in a few days. These funds can offer them more efficient & better returns on their money lying in current accounts.

  • Retail Investors

Investors who have an investment horizon of a week or less can consider investments in overnight funds. Otherwise, for horizons longer than a week, it would be better to consider liquid funds which can offer higher returns along with good safety.

Investors can also look at parking their money in overnight funds for the purpose of making transfers to other mutual fund schemes using STP (Systematic Transfer Plan). 

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