Hello everyone. This is my first post on this forum. I hope
this post is on-topic. While this post isn’t about investing in
equities, which I think is what this forum is mostly about,
it’s closely connected. Apologies in advance, because this is
going to be verbose.
I’m trying to understand the differences between overnight
funds and a bank savings account or fixed deposit in terms of
safety. These are both common ways to park money for short
periods.
I know that overnight fund is a kind of debt fund where the
debt instruments mature overnight. But there are still a number
of things that are unclear to me about it.
My major concern is safety of the principal. But to determine
safety, it’s helpful to know exactly what is being done with
the money. As the saying goes: what you don’t know can hurt
you. And also, the devil is in the details. (The latter is a
saying I really like.)
Traditionally, the standard way in India to hold money is in a
savings account or FD. However, savings accounts/fixed deposits
in India are not safe. Indian deposit insurance is among the
lowest in the world. It was until recently 1 lakh per account,
and I believe that this has recently been increased to 5 lakhs
in light of the PMC debacle. This is in contrast to USD 250,000
for the USA, and Euro 100,000 for the EU. Also, my understanding is that in the case of bank failure, even this amount will not be made available immediately, but only once the bank is liquidated, which may take years.
Since deposit insurance is so grossly inadequate, in case a
bank runs into trouble, it needs to get help from the govt. But
cooperative banks fail all the time, and the govt does nothing
to help them. PMC is just the largest of such events, so made
the news in a way that the others did not. However, the govt
apparently sees nothing wrong with allowing thousands of unsafe
cooperative banks to continue functioning, nor does it try to
protect the public in any way from the possible consequences of
failure. For example, it has never, to my knowledge, ever
issued any safety warnings about banks. So an obvious defensive
ploy is to only keep money in banks that are large enough that
the govt will be compelled to bail it out. The so-called “To
Big To Fail” banks. I checked, and apparently SBI, HDFC, and
ICICI currently fall into that category. But it would be really
nice not to have to depend on a bail out in the event of a
problem.
In light of the above, the idea of an overnight fund seems
quite appealing. But it’s a good idea to take a long and hard
look at it first.
The article
is one of the few places where I found a discussion of
comparative risks. The author writes:
Unlike debt funds, the risk of concentration is high in
investments like fixed deposits where investors hold large
sums of money and run the risk of losing it all if things go
wrong. There is very little information available to
investors that they can use to evaluate their investments and
they have very few options for exit or redressal.
Open-ended funds, on the other hand, are required to provide
regular information on portfolio and performance to investors
and can exit at the current value of the units at any time.
So the author is saying that if one has an account with ICICI,
for example, all ones risk is concentrated in one bank/company.
It’s ironical he should mention information on portfolios,
because my question is largely about the overnight fund
portfolios.
https://www.sbimf.com/en-us/lists/sid_kim/sid%20-%20sbi%20overnight%20fund.pdf
In many places, overnight funds are mentioned as an alternative
to bank deposits (savings account or fixed deposit. But it’s
not clear to me how the respective risks compare. I’m also
still not clear what the risk of a overnight fund is,
exactly. It’s described in various places as “low risk”, but
I’m not sure what that translates to in concrete terms.
I know that debt funds in general list their portfolio, so one
should look at that for more details. However, looking at this
hasn’t been particularly enlightening. I looked at some
overnight funds (sample
list).
The SBI fund is the oldest, apparently having begun on October
01, 2002
All the overnight fund portfolios I’ve looked at have the
following in various proportions, but nothing else: Reverse
Repo, Net Receivables, TREPS. Usually one of these three is
dominant.
For example, the SBI overnight funds breaks down as follows:
Reverse Repo (sometimes just Repo) 99.10%
Net Receivables 0.63%
TREPS 0.27%
I’m not completely sure what any of these terms mean. Here are
some guesses.
Reverse Repo/Repo: This is vague. Repo is short for repurchase
agreement. Repo and Reverse repo are general terms, but it’s
possible it is being used in a specific sense in this case. The
general sense is that some entity (possibly a central bank)
sells a bond to the overnight fund for an overnight people, and
then buys it back the next day at a higher price, i.e. the
original price plus interest. In other words, the entity is
borrowing money overnight from the overnight fund.
In this case, it’s possible that the entity is the RBI, but
this is just a guess. It might be others. And digging around in
the records of overnight funds revealed no additional
details. If the entity that the overnight fund is doing
business with is exclusively the RBI, then an obvious question
then is - is the RBI willing to sell as many bonds as the
overnight fund wants?
TREPS: This appears to correspond to something called a
Triparty Repo (FAQ - TREPS),
which is a repo contract using a third party as
intermediary. Would this third party hold collateral? It’s not
clear. It’s also not clear how this differs from Repo/Reverse
repo. Does Repo/Reverse repo not involve a third party?
I found the Wikipedia Article
helpful when trying to understand what repurchase agreements
are.
Net Receivables: I’m not currently sure what this is. But a
search bought up this question on tradingqna.com,
Net Receivables in Mutual Funds - #5 by Bhuvan - Personal finance - Trading Q&A by Zerodha - All your queries on trading and markets answered
but I didn’t find the answers there convincing.
Finally, this might be a dumb question, but what is stopping an
individual doing what these funds are doing?
