What is Liquid ETF, And How Does It Help To Optimize Stock Market Returns?

Investing in the equity market is not just about selecting the right stock and exiting at the right time but also about optimizing return. Unfortunately, most investors choose a savings or broker’s account to park their trading capital, which doesn’t yield any returns or inefficient returns. And one way to optimize returns or make your idle trading capital yield returns is by investing in liquid ETF. 

So, what are liquid ETFs, and how can investors benefit and optimize returns using them? Let’s try to understand 

What are Liquid ETFs?

Liquid ETFs or exchange-traded funds are mutual fund units traded on the stock market like any other ordinary stock. The ETF invests in Tri-party Repo/Repo & Reverse Repo or simple words, debt and money market securities with maturities of up to 91 days. These instruments are known for their low credit risk profile and high liquidity levels. 

The returns generated are pretty stable and predictable, and because liquid ETFs invest in short-term debt securities, the interest-rate risk is the lowest. 

Liquid ETFs in India

In India, there are three liquid ETFs traded on the stock market- Nippon India ETF Liquid BEES (NSE: LIQUIDBEES), DSP Liquid ETF (NSE: LIQUIDETF), and ICICI Prudential Liquid ETF (NSE: ICICILIQ). The liquid ETFs can be bought and sold just like a stock using a trading account and has the same settlement cycle of T+2 days. So here, T+2 means trading plus two days. 

The price of all three ETFs stays constant at ₹1000, and the returns are generated as daily dividends, which the fund house credits to the holder’s Demat account in the form of ETF units once every 30 days. 

Keeping the daily NAV of liquid ETF at ₹1000 and choosing the dividend option for returns is to avoid charging for capital gains tax, which could have wiped off a significant part of the gains. Since the returns of Liquid ETFs are generated in the form of dividends, they are taxed in the hands of investors at their income tax slab.

Liquid ETF Returns

Liquid ETFs are known for having a very stable and predictable returns profile. The screenshot below showcases the returns profile of Nippon India Liquid BeES. The returns are equal to overnight mutual funds or repo rates.

NAV as on August 31, 2022: Rs. 1,000.0000

How can Liquid ETFs Optimize Stock Market Returns?

For an equity investor or F&O trader, it’s pretty common to book profits and reinvest them as per evolving market conditions. But, the duration between booking profits and reinvestment can range between a few days to weeks. Therefore, most of them prefer to park the unused trading capital in the trading account for quick deployment during the period. 

And, also after the sale is complete, the funds are available to investors only after T+2 days, which impacts traders’ ability to access funds quickly. Furthermore, F&O traders need to transfer funds to raise margin funds, which is time-consuming and risks the chance of missing out on trading opportunities. So, it is where liquid ETFs come to the rescue as an efficient cash management tool. 

Benefits of Liquid ETFs for Investors

Investors can get two benefits and improve the overall return percentage on investments by investing in liquid ETFs.

Quick conversion to liquid ETF: In the typical case, the fund from the selling stocks is available for withdrawal after T+2 days. But, if you choose to invest the same amount in a liquid ETF, you can instruct your stock broker to purchase an equal amount of liquid ETF on the same day of selling the equity stocks. Therefore, on the settlement day of equity stocks, the units of liquid ETFs will be credited to your Demat account. 

You can continue holding the units of liquid ETF in your Demat account until you get a new opportunity to invest and earn some returns during the period. Once you spot a chance, you can instantly liquidate the liquid ETF and buy the stock. In an emergency, you can readily convert the units into cash too. 

High loan-to-value (LTV) offered for margin funding: Liquid ETFs are considered cash equivalent by brokers, meaning they have the same value as cash. In F&O trading, you can offer liquid ETFs as collateral for margin funding, and most brokers offer up to 90% of the value of liquid ETFs as margin to traders. 

In overnight F&O trades, at least 50% of the margin should come from cash or cash equivalent collateral, and the remaining 50% can be in the form of a non-cash collateral margin. Here, liquid ETF reduces the complexity for traders and lets them earn additional returns too. 

Conclusion

Liquid ETFs are not for investment purposes but are designed for parking surplus funds for a short duration while providing modest returns and on-demand liquidity with the lowest risk. Therefore, making it a viable option for large retail investors and institutions as an effective cash management tool. Do not compare it with other liquid mutual funds or savings instruments.

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