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What are Liquid ETFs? Things to know before buying Liquid ETFs

When a stock market investor liquidates or sells off his investment, he faces two issues before he reinvests his money into a new stock.

Let's say that you invest in the stock market. Over the past few months, the value of your investment in Stock A increased and you are now selling it to earn profits. You place your sell order on day 1. The stock gets debited from your Demat account on day 2, and you receive your sell proceeds in your margin account on day 3.

You can now keep the money in your margin account until you find a new investment or initiate a payout to your bank account.

Now, as a stock market investor, your first dilemma will be that this money will stay idle in your margin account and not earn any interest and therefore not give you any returns. And the second is that you will also have to spend a considerable amount of time and energy in transferring money between your trading account and your bank account.

Is there one simple solution that can tackle both of these issues? Of course there is!

Introducing, Liquid ETFs. A liquid ETF, or Exchange Traded Fund, as the name suggests, is a mutual fund whose units are traded on the stock exchange. They invest in low risk overnight securities like Collateralized Borrowing and Lending Obligations (CBLO), Repo and Reverse Repo securities.

What are these, you ask?

Well, CBLO is a money market instrument that enables entities to borrow and lend against sovereign collateral security. The maturity ranges from 1 day to 90 days and can also be made available upto 1 year. Central Government securities including T-bills are eligible securities that can be used as collateral for borrowing through CBLO..

Repo refers to repurchase agreements in the form of short-term borrowing for dealers in government securities. The dealer sells the government securities to investors, usually on an overnight basis, and buys them back the following day.

For the party selling the security and agreeing to repurchase it in the future, it is a repo. And For the party buying the security and agreeing to sell in the future, it is a reverse repurchase agreement, or Reverse Repo.

Repos are typically used to raise short-term capital.

Liquid ETFs pay dividends on a daily basis, which is then reinvested into the fund. The aim of a liquid ETF is usually to provide an income commensurate with low risk, but at the same time, providing a high level of liquidity.

It is this high liquidity which makes Liquid ETFs the perfect solution to your conundrum.

When you place your sell order on Day 1, you can simultaneously buy liquid ETF units on the same day. On Day 2, your stocks are debited from your demat account and on Day 3 the liquid ETFs will be credited to your demat account and you will start earning returns in the form of daily income . So no money will sit idle. This basically allows investors in the liquid ETF to start receiving returns on their investments from the date of settlement of their trade.
And since liquid ETFs are highly liquid, you could conveniently sell units easily to invest back into the stock market as and when an opportunity arises.

The advantages of Liquid ETFs are:

  • Help earn more returns: Your money is always earning you interest, rather than sitting idle in the margin account or earning negligible to no returns in a savings account. Also, as soon as the settlement of the trade is cleared, liquid ETFs start giving returns thus avoiding days of lost returns.
  • Highly liquid: It is highly liquid, so you’ll be able to invest when you find an attractive investment opportunity. You can buy and sell liquid ETFs both from the market as well as the issuing Mutual Fund.
  • Saves effort: Investors no longer need to make unnecessary transactions or move money between the trading account and the bank account. Liquid ETFs also help avoid the need to go through the trouble of waiting for cheques to clear, or making electronic transfers to a trading account.
  • Can be used for margin: While buying or selling stocks, it takes 3 days to complete a trade. To avoid the inconvenience of issuing cheques or making electronic transactions each time, some traders keep some margin with their brokers. However, this margin (money) does not earn any returns. You could purchase liquid ETF units worth the margin you want to maintain and earn returns till the time it is used to purchase stocks.

The things you need to be careful about when buying Liquid ETFs are as follows:

  • Fractional units: Liquid ETFs give returns in terms of increase in units, which can add small fractions to existing holdings; fractional units cannot be sold on the Exchanges. However, the issuing mutual fund (MF) house purchases back the fractional units.
  • Brokerage charges: Investors may have to pay brokerage while purchasing liquid ETF units, and brokerage charges vary from broker to broker. Most brokers may not charge any brokerage on the purchase of these products thereby increasing their appeal for investors. It is advisable for investors to confirm the brokerage amounts that they will be charged on trades in liquid ETF before making a purchase. Besides, not only are liquid ETFs convenient to purchase and hold, it is much quicker than moving money between your bank and the broker.
  • As Liquid ETF fall under the category of Specified Mutual Funds (Whose exposure to domestic equity shares is less than 35%), any investment made after April 01,2023 will be deemed as short term asset and will be taxable as per income slabs applicable to investor.

Liquid ETFs are particularly suitable for large retail traders and investors, Portfolio Management Services (PMS) providers, Futures & Options (F&O) brokers and institutions which invest directly in equities. These funds are also suited to the needs of High Net Worth Individuals (HNIs) as many times, these investors may have funds lying idle either in a trading account or they may be maintaining margin money with their brokers on which no returns are earned. By parking funds in liquid ETFs, investors can earn returns on idle funds while also remaining liquid to benefit from attractive investment opportunities.

To conclude, liquid ETFs can help make trading more profitable if used in the right manner. And that too, in a much easier and convenient way!

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Key Takeaways

  • Liquid ETFs (Exchange Traded Fund) are mutual funds whose units are traded on the stock exchange.
  • They invest in low-risk overnight securities like Collateralized Borrowing and Lending Obligations (CBLO), Repo and Reverse Repo securities.
  • The aim of a liquid ETF is usually to provide an income commensurate with low risk, but at the same time, providing a high level of liquidity.
  • By parking funds in liquid ETFs, investors can earn returns on idle funds while also remaining liquid to benefit from attractive investment opportunities.
  • Advantages: Potentially more returns (as compared to money idle in the margin account or a saving account), high liquidity, convenience (since you no longer need to make unnecessary transactions or move money between your trading and bank account) and the ability to use these investments as margin money.
  • When buying liquid ETFs, be aware that fractional units can be only sold back to the issuing MF and that there could be brokerage charges while transacting.
  • Liquid ETFs are particularly suitable for large retail traders and investors, Portfolio Management Services (PMS) providers, Futures & Options (F&O) brokers and institutions which invest directly in equities, and High Net Worth Individuals (HNIs).