Thus, besides a parking space for your capital till you decide what to do with that money, liquid funds are an ideal option to safeguard capital and earn stable returns amidst choppy markets.

Investment horizon
As the name suggests, liquid funds primarily invest in debt instruments with less than one year of maturity period. For example commercial papers, certificate of deposits, treasury bills and call money market. Besides, these funds take marginal exposure in debentures with residual maturity of less than one year. The short-maturity profile reduces the interest rate sensitivity of the portfolio.

This is attributed to the cardinal rule that governs the bond markets - as interest rates rise, price of debt instruments falls and vice-versa with the impact more pronounced in instruments with longer maturity tenure. For instance, the average maturity profile of the category for January 2001 was merely 2.04 months against the average 40 months for bond funds.

Short-term debt funds
While most liquid funds have a high minimum investment, some funds charge a lower entry ticket. Typically, minimum investment ranges from Rs 25,000 to Rs 5 lakh, which makes these funds a suitable investment for high networth individuals. At the same time, a sizeable investment is also required in these funds for differential gains to be meaningful in absolute rupee terms.

Packaged with minimal risks, liquid funds are a smart option to invest short-term surplus. With the deal for your dream house a couple of months away, you may want that money to earn some decent returns without risking principal. While equity schemes are a strict no, bond funds too can be volatile with your redemption coinciding with turbulence in debt markets.

Short-term debt funds are also a worthy replacement for short-term bank deposits and savings accounts. While these funds offer liquidity with convenience very close to those from banks, they also yield higher returns.

A striking difference - Investors cannot use their liquid fund for issuing third-party cheques like paying for telephone and electricity bills.

Product differentiation
With returns separated by a few basis points in most liquid funds, service standards become an important benchmark for selecting a fund. We highlight some of the facilities provided by liquid funds.

Sunday NAV facility: Some funds now offer "Sunday" NAVs. This means that there will be no loss of interest income to an investor redeeming on Monday. Previously, redemption was priced at Friday's NAV.

The Sunday NAV is also applicable if an investor redeems on Friday since the cheque, in this case, can be delivered only on a Monday.

Cheque-writing facility: Some of the short-term debt funds provide greater ease of withdrawal by providing limited cheque writing facility for upto 95 per cent of the initial investment besides a systematic withdrawal facility.

For instance, investors in Prudential-ICICI Liquid Plan can withdraw any amount over and above Rs 15,000, provided they have an account with ICICI Bank.

Expense ratio: With only a marginal variation in returns and a short stay in liquid funds, expenses matter. Thus, opt for a fund with low expenses. The average expense in these funds was an average 0.95 per cent as on March 31, 2000.

The primary objective of liquid funds is preservation of capital while returns are secondary. Thus, it is important that you invest in a fund with stable gains rather than one with a wide variation in returns. Here are three funds with low standard deviation of weekly returns in their category.Launched in June 1998, Prudential ICICI Liquid Fund has given an annualised return of 9.68 per cent.

An actively managed fund, it charges a 0.25 per cent load for redemptions within 5 days. The oldest fund in its category, Birla Cash Plus has posted a consistent return of 9.57 per cent since launch in June 1997.

While the fund is available on a no-load basis, it has a relatively high expense ratio at 1.18 per cent. Launched in June 1998, Templeton India Liquid has a track record of steady performance, with a return of 9.95 per cent. This no-load actively managed fund requires a minimum investment of Rs 25,000.

Value Research