Exchange-traded funds (ETFs) have become an increasingly popular investment vehicle due to their flexibility, liquidity, and the variety of assets they can encompass. Among the various types of ETFs available, liquid ETFs are one of the less known ETFs that can have many use cases for investors. This blog will delve into what liquid ETFs are, where they invest, their safety, uses, and the taxation rules that apply to them.

 What Are Liquid ETFs?

Liquid ETFs are a type of exchange-traded fund that invests primarily in short-term, highly liquid money market instruments. They are designed to provide investors with a relatively safe, low-risk investment option that can be easily converted into cash. Here are some key features:

• Tradability: Like stocks, liquid ETFs can be traded on the stock exchange throughout the trading day, providing high liquidity. They are listed in both NSE and BSE.
• Dividends: Generally, in most liquid ETFs, investors receive dividends in the form of additional units credited to their Demat account. These ETFs may also offer direct credit of dividend to the bank account on a monthly basis or a growth NAV.
• Popular Listings: Some of the popular liquid ETFs listed on NSE and BSE are Nippon India ETF Nifty 1D Rate Liquid BeES, DSP NIFTY 1D Rate Liquid ETF, and ICICI Prudential S&P BSE Liquid Rate ETF.
• Settlement Cycle: The typical settlement cycle for these ETFs is T+1, meaning transactions settle one business day after the trade date.
• Fractional Units: Units credited to a Demat account in the form of dividends can be in very low fractions, meaning you can’t sell them in the market. However, these can be redeemed from the respective Asset Management Companies (AMCs) that buy back the units from investors.

Where Do They Invest and Is It Safe?

Liquid ETFs primarily invest in ultra-short-term instruments, ensuring high liquidity and minimal risk. Their typical investments include Tri-Party REPOs, Government Securities, REPOs, Reverse REPOs, etc. These instruments are chosen because they are considered as risk-free as possible. Around 99% of liquid ETFs' allocation is towards fully collateralized tri-party repos, which mitigates default risk even if a borrower defaults, since the loans are fully backed by collateral.

What Are the Uses of These ETFs?

Liquid ETFs offer several practical uses for investors:

• Cash Management: Investors can park their cash in liquid ETFs to earn returns, avoiding the inefficiency of idle cash in trading accounts. This is often more convenient than transferring funds to bank accounts or fixed deposits (FDs) or investing in debt mutual funds (MFs).
• Asset Allocation: Asset allocation is the cornerstone of effective portfolio management. The ETFs can be used for parking a part of the portfolio in cash. Cash allocation in the portfolio is added to mitigate portfolio risk and can be increased or decreased by investors depending on the market scenario.
• Pledging: Liquid ETFs can be pledged with a very low haircut (usually not more than 10%), providing liquidity equivalent to cash without the need to sell the ETF itself for trading stocks.

Taxation

Understanding the tax implications is crucial for any investment decision. For liquid ETFs:

• Dividends: Dividends in the form of units or credited to the bank account are taxed according to the investor's income tax slab rates.
• Capital Gains: In case of growth based liquid ETFs, the capital gains are taxed at slab rates irrespective of short-term or long-term capital gains.

Conclusion

Liquid ETFs provide a flexible, low-risk, and liquid investment option for managing cash efficiently and earning returns on idle funds. Their ease of trading, safety, and practical uses make them an attractive choice for both individual and institutional investors.

~ Nischay Avichal