The Comparison Between Liquid Funds and Liquid Exchange-Traded Funds (ETFs)
Liquid Funds Offer Higher Returns Than Liquid ETFs in India
In the Indian market, liquid funds generally provide higher returns compared to liquid Exchange-Traded Funds (ETFs). This is due to the investment strategy of liquid funds, which diversifies into a portfolio of short-term money market instruments, and their low risk profile.
Top-performing liquid funds like Edelweiss Liquid Fund and Aditya Birla Sun Life Liquid Fund offer around 7.3% returns over two years[3][5]. On the other hand, Nifty 1D Rate Liquid ETFs, which track overnight money market rates, report 1-year returns closer to 4%-6%, with the highest being the Zerodha Nifty 1D Rate Liquid ETF at about 6.0% over one year[1].
The key difference in returns is due to the investment strategy of liquid funds. They invest in a diversified portfolio of short-term money market instruments, such as commercial papers, certificates of deposits, and treasury bills, with a maturity cap of 91 days[3]. This allows for potentially higher yields. In contrast, Nifty 1D Rate Liquid ETFs are designed to track the overnight money market rate, which is typically lower and more stable, reflecting a very short-term horizon with negligible tracking error[1].
Liquid funds also charge expense ratios and sometimes have minimal exit loads, but overall, their returns tend to be relatively higher, providing better compensation for investors who do not require a trading account[2].
From a practical standpoint, if you are seeking slightly higher returns and direct investment ease, liquid funds are preferable. However, if you require intraday trading flexibility or the transparency of ETFs, a liquid ETF may suit, although it comes with somewhat lower returns on average[4].
For individuals without a Demat account or those who do not trade, liquid funds are a better investment option. Liquid ETFs, which trade on the stock exchange like stocks, with a trading price of Rs. 1,000, can earn returns on idle cash in a trader's or direct equity investor's account.
Redemption of money from liquid funds can be done through the fund house, distributor, or individually. The margin provided on pledged liquid ETFs may vary between brokers. Liquid funds provide the convenience of selling fractional units, while redemption of fractional units in liquid ETFs is not possible; they can only be sold when they become whole units. Dividends from liquid ETFs are reinvested in the ETFs, resulting in fractional units.
In summary, liquid funds generally offer higher returns than liquid ETFs in India, mainly due to their investment in a broader short-term portfolio and not being restricted solely to overnight rates[1][3].
Investing in mutual funds such as liquid funds can offer higher returns compared to liquid ETFs, as they diversify into short-term money market instruments and have a higher potential for yields. Debt funds, a type of mutual funds, also invest in short-term money market instruments but may not provide returns as high as liquid funds. In personal-finance, for individuals seeking higher returns while having the convenience of direct investment, liquid funds could be a suitable choice. However, liquid ETFs may be more preferable for those who require intraday trading flexibility or the transparency of ETFs, despite having lower returns on average. Finance experts suggest that for individuals without a Demat account or those who do not trade, liquid funds are a better investment option.
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