Smart Way to Stash Your Cash

Ever since they came into being, they have yielded little more than a short-term bank deposit. If you are willing to settle for non-guaranteed return and assume little risk for some extra return, cash funds could be a worthy proposition. These funds largely invest in money market instruments like treasuries and commercial paper, issued by corporates.

The minimum investment for these funds could start from as low as Rs 5,000 to as high as Rs 1 lakh. But for differential gains to be meaningful in absolute rupee terms, investment here makes sense only if you have a sizeable cash position—Rs 1 lakh or more.

For large investors cash funds could be a better deal than short-term bank deposits and savings accounts. Budget 2002 made dividends from all bond funds to be taxed at the hands of the investor, in accordance with the tax bracket an individual falls into. Also, while the limit of interest income from bank deposits has been reduced from Rs 12,000 to Rs 9,000, banks also deduct tax at source on interest above Rs 5,000. But one can derive another tax advantage. The short-term loss you incur elsewhere can be offset against the gain in these funds.

Cash funds have posted an 8.4% return over the past one year (Average Daily Rolling Return). This looks handsome, given their stability against increased interest rate volatility. They also prove to be least volatile fund category with lowest standard deviation, a measure of volatility. The 3-year average standard deviation of 16 cash funds was 0.25 as on August 31, 2002 as against a standard deviation of 0.8 in case of a medium-term bond fund.

As rates rise, bond prices fall and vice-versa. Incidentally, the impact of rate cuts is not the same on all bond funds; it varies from one fund to the other. They are the least volatile fund category with lowest standard deviation, a measure of volatility. As short-duration funds are less interest-rate sensitive and have historically offered less upside potential than funds with a longer duration. Falling interest rates gave bond funds a big boost, as was evident last year. While medium and long-term bond funds were the biggest beneficiaries, short-term funds made some substantial gains.

Of late, the yield on cash fund has slipped—an average 8.4% against the 9.10% return turned by in 2001. Still these funds are a worthwhile offering. In 2001, falling interest rates and an economic slowdown gave bond funds a big fillip, particularly long-term bonds, which registered sharp movements during the year. On the other hand, short-term fund category too posted decent returns. If interest rates move up, this increase would hike the short-term bond yield too. Before you consider replacing cash with a cash fund in your portfolio, look beyond yields. Anyway, the yield difference of the best and worst fund in this category is marginal. I suggest that you place a premium on low expenses, besides stability, consistency and serviceability. My picks among cash funds include:

Alliance Cash Manager: This fund doesn’t take chances. Launched in May 1998, it sticks to AAA bonds and P1+ securities, which eliminates chances of both credit and liquidity risks. Since launch Alliance Cash Manager has clocked a 8.69% return while and its year-to-date return is 4.89%.

Birla Cash Plus: Another choice that keeps a lid on volatility and provides minimal credit risk. Launched in June 1997, the fund has turned in a 9.07% return since launch and its YTD return is 4.94% This fund’s portfolio comprises commercial papers, treasury bills and AAA debentures besides parking some portion in call money.

DSPML Liquidity: This fund is pretty steady. Launched in March 1998, the fund aims to generate reasonable returns commensurate with low risk and high liquidity by investing about 80% of the corpus in money market instruments, with the remaining accounted for by debt instruments. The fund has registered 8.17% return since launch and its YTD return stands at 4.97%.

The author is the chief executive of ValueResearch, which tracks mutual funds. He can be reached at dhiren@valueresearchindia.com