MONEY MARKET MUTUAL FUNDS

or LIQUID MUTUAL FUNDS - AN INTRODUCTION

Rama Krishna Vadlamudi BOMBAY

November 24th, 2009

Money Market Mutual Funds primarily invest in money market mutual fund
instruments, such as, commercial papers, CBLO, certificates of deposit, treasury
bills and call money market for a shorter duration. They invest in securities that
are easily convertible into cash.

MMMFs are governed by SEBI and are popularly known as liquid mutual funds in
India. The salient features of an MMMF are:

• It is an open-ended mutual fund scheme meaning one can enter at any

time and money can be withdrawn at any time
• Provides high liquidity along with current income
• Highly liquid meaning it can be redeemed at a very short notice
• Minimum investment can be as low as Rs.5,000/-
• Some schemes offer bank type convenience - can invest or withdraw any
day (subject to certain rules)
• Some funds offer withdrawal by cheque (as per applicable rules)
• Invests in high-quality money market instruments (mostly P1+ or AAA+
rated)
• Investments are subject to market risks and the net asset value of an
MMMF may fluctuate depending on factors affecting the Money Markets
• Investments in money market instruments are subject to default risk and
interest rate risk. Interest rate risk results from changes in demand and
supply for money and other macro economic factors and creates price
changes in the value of debt instruments. (During the liquidity crisis of
September-December 2008, a few liquid and liquid plus funds – not only in
India but also in the US – had suffered some losses due to default risk)
• However, from a practical perspective, the above risks from liquid funds
are almost NIL as long as the market regulators do their job well
• Investments in money market instruments are subject to reinvestment
risks as interest rates prevailing on interest or maturity due dates may
differ from the original coupon of the bond, which might result in the
proceeds being invested at a lower rate

Rama Krishna Vadlamudi, BOMBAY. www.scribd.com/vrk100. Nov. 24th, 2009 Page 1 of 6

MONEY MARKET INSTRUMENTS:
They include commercial papers, commercial bills, treasury bills, call or notice money,
certificates of deposit, usance bills, CBLO (collateralized borrowing and lending
obligation of the CCIL), repos / reverse repos, structured obligation, debentures and any
other like instruments as specified by the Reserve Bank of India and SEBI from time to
time including MIBOR-linked securities, short-term bank fixed deposits and call products.

SEBI’s NEW RULE:

The ‘liquid fund schemes and plans’ shall, with effect from May 01, 2009, make
investment in /purchase debt and money market securities with maturity of up to
91 days only, according to a new rule by SEBI.

GENERAL POINTS:
• Liquid mutual fund schemes give much better returns (post-tax) as compared to
other shorter-term bank fixed deposits or savings bank (SB) accounts for
investors in higher tax brackets
• Mutual Funds in India manage about Rs 1.04 lakh crore under liquid funds
category (as of October 31, 2009)
• For investing in liquid schemes, no demat account is required
• You can invest in a liquid fund through any Mutual Fund office or other
distributors; like, banks, etc
• There is no entry load on these funds and there is no exit load also
• Investment in liquid mutual fund is easy and convenient. Investors have to fulfill
KYC (know your customer) norms.
• Investors can withdraw their money at any point of time. It will take two or three
days to withdraw money as the application for withdrawal will take a few days to
process
• There are several well-known liquid mutual fund schemes, like, HDFC Cash
Management Savings Plan, Templeton India Money Market Account (TIMMA is
the first MMMF in India), Birla Sun Life Cash Manager, SBI Magnum InstaCash,
LIC MF Liquid fund, Quantum Liquid fund, DWS Insta Cash Plus Regular,
Canara Robeco Liquid Retail fund and UTI Money Market Mutual Fund.

LIQUID FUND RETURNS AS ON NOV. 23, 2009

CAGR 1-week 1-month 3-month 6-month 1-year

% % % % %
LIQUID FUNDS
3.12 3.36 3.36 3.66 4.92
CATEGORY

source: ValueResearch Return % are annualized

NOTE: The returns from liquid funds have fallen in the last six months
(after SEBI’s new rule mentioned above) as they cannot invest in
instruments with maturity above 91 days and due to high liquidity in the
banking system. However, in the next three months, the annualized returns
may improve to four or five per cent depending on the interest rate cycle.

Rama Krishna Vadlamudi, BOMBAY. www.scribd.com/vrk100. Nov. 24th, 2009 Page 2 of 6

 Difference between Liquid funds and
Money Market Mutual Funds (MMMFs)

(NOTE: As far as mutual funds in India are concerned, the important provisions for MF
regulation are contained in: 1. SEBI ACT OF 1992; 2. SEBI (MUTUAL FUNDS)
REGULATIONS, 1996; and 3. Various circulars issued by SEBI from to time.)

MONEY MARKET MUTUAL FUND:

SEBI (MUTUAL FUNDS) REGULATIONS 1996, define the terms, ‘money market
instruments’ and ‘money market mutual funds.’ As per clause 2 (o) of these
regulations, the term “money market instruments” includes commercial
papers, commercial bills, treasury bills, Government securities having an
unexpired maturity of up to one year, call or notice money, CBLO (collateralized
borrowing and lending obligation of the CCIL), certificate of deposit, usance bills,
and any other like instruments as specified by the Reserve Bank of India from
time to time;
As per clause (p), “money market mutual fund” means a scheme of a mutual
fund which has been set up with the objective of investing exclusively in money
market instruments.

LIQUID FUND:
The term, ‘liquid’ fund was first defined by SEBI in its circular dated 11.10.2006.
And subsequently, the term ‘liquid’ fund’s definition has been amended vide SEBI
circular dated 19.01.2009 amending, inter alia, the nomenclature of liquid and
liquid plus schemes.
In terms of the above two circulars, the main characteristic of a LIQUID FUND
SCHEME is that the scheme has to compulsorily invest in debt and money
market instruments with maturity of up to 91 days only. (It is inferred that if any
scheme invests in debt and money market instruments of maturity of more than
91 days, it cannot be considered as a liquid fund/scheme.)
My take on the difference between liquid funds and money market mutual
funds:

Liquid fund scheme can invest in debt and money market instruments of a
maturity of not more than 91 days. Whereas, an MMMF can invest in
money market instruments (as per definition mentioned above) of maturity
of less than or equal to 91 days or money market instruments with
maturity of more than 91 days also (as per definition mentioned above);
but up to one year only

Rama Krishna Vadlamudi, BOMBAY. www.scribd.com/vrk100. Nov. 24th, 2009 Page 3 of 6


While liquid fund scheme can invest in debt as well as money market
instruments; an MMMF cannot invest in any instrument other than money
market instruments (as defined above). For an MMMF, the money market
instrument can have a maturity of more than 91 days also, but up to one
year as defined above.

As one must have observed, there’s an overlap in the definitions of liquid and
MMMF schemes and this is creating confusion among the minds of investors. I
hope the above clarification clears the air.

Tax Treatment of Growth Plans of Liquid funds

for Resident Individuals

1. LONG-TERM CAPITAL GAINS TAX (LTCG): Suppose a resident individual

has invested money in the growth plan of a liquid MF scheme. If she keeps the
units for more than a year, the profit from the sale of such units will be subject to
long-term capital gains tax at the rate of 20 per cent (including education cess, it
comes to 20.60 per cent) with indexation benefit. Without indexation benefit, the
tax liability will be 10.30 per cent including education cess.

2. SHORT-TERM CAPITAL GAINS TAX (STCG): Suppose a resident individual

has invested money in the growth plan of a liquid MF scheme and she sells the
units within one year from the date of investment. The profit from sale of such
units will be included in her taxable income and taxed according to her individual
tax slab (that is, marginal rate of tax).

Tax Treatment of Dividend Plans of Liquid funds

for Resident Individuals

Returns received from dividend plans of liquid MFs are tax-free in the hands of
resident individuals; however, mutual funds deduct a dividend distribution tax
(DDT) of 25 per cent (including three per cent education cess, it works out to
25.75 per cent) and pays the remaining dividend to the unitholders. To that
extent, the return from dividend plans will be lesser.

Rama Krishna Vadlamudi, BOMBAY. www.scribd.com/vrk100. Nov. 24th, 2009 Page 4 of 6

 Tax Treatment of Mutual Funds in India

LONG-TERM CAPITAL GAINS TAX * SHORT-TERM CAP. GAINS TAX *

INIDIVIDUAL CORPORATE INIDIVIDUAL CORPORATE

Equity
NIL NIL 15.45% 16.995%
MFs

10.30%
without 11.33% without Taxable as per the
Debt MFs indexation indexation
# rate applicable to 33.99%
20.60% with 22.66% with the investor
indexation indexation

* Individual - includes education cess of 3%

* Corporate - incl. surcharge 10% and edu. Cess of 3%
# Debt MFs include liquid and money market mutual funds

DIVIDEND DISTRIBUTION TAX (DDT) * As per Section 115R of the IT

Act, DDT is payable by debt
INIDIVIDUAL CORPORATE mutual funds including liquid
funds or money market mutal
Equity MFs NIL NIL funds (MMMFs) on dividends
distributed by them to
unitholders.

Debt MFs excl. 12.875% 22.66% * For individuals, DDT includes

liquid funds education cess of 3% and for
corporates, DDT includes
Liquid MFs or surcharge of 10% and
MMMFs 25.75% 28.325% education cess of 3%.

For my write-up on GOOD LIQUID MUTUAL FUNDS dated November 24th,

2009, just click:

http://www.scribd.com/vrk100

OR

http://groups.google.co.in/group/random-thoughts-on-investments/files?hl=en&&sort=date

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