Why does Quantum Liquid Mutual Fund underperform its Benchmark?

Posted On Friday, Aug 05, 2016


Recently we received a query from an investor of ours asking why the Quantum Liquid Fund's returns have been lower than the benchmark and our peers. Given that transparency is the cornerstone of our philosophy, we would like to take this opportunity to explain Quantum Liquid Fund's investment strategy to you, dear investor, as well as the reasons for the underperformance (which we openly admit may continue in the foreseeable future!).

Let us begin with the basic definition of a liquid fund.

A liquid fund is a category of debt mutual fund which invests primarily in money market instruments like Certificates of Deposit, Treasury Bills, Commercial Paper, and Term Deposits. These money market instruments provide easy liquidity. Traditionally, a liquid fund is viewed an alternative to savings bank accounts, in which one wants money to be less risky and available at short notice. Liquid funds, ideally, should not be looked at as a source of generating excess returns.

Liquid funds are made for short term investments of up to 91 days. By investing in less-than-91-days paper, the portfolio reduces volatility due to interest rate movement. Investors are however exposed to potential credit risk in the liquid fund portfolio.

At Quantum, we try to reduce this credit risk in the liquid fund portfolio. Quantum Liquid Fund has three objectives, namely Safety, Liquidity, and Returns - in that order. We would like to explain this strategy with help of the following points.

Quantum Liquid Fund currently invests only in Treasury bills, PSU banks' Commercial Deposits, and AAA rated PSU Commercial Papers. These are all are very liquid and have low credit risk instruments. However, their returns are also slightly lower as they have lower credit risk. Remember the old investment adage - the higher the risk, the higher the return? Vice versa also holds true - the lower the risk, the lower your returns.
The fund may deliver lower returns compared with the benchmark fund (Crisil Liquid Fund Index) and other Liquid Funds available in the market due to the difference in the composition of the portfolio of the fund and that of the benchmark index.
The benchmark for Quantum Liquid Fund is the Crisil Liquid Fund Index, which is comprised of Certificates of Deposit, Call Money, and Commercial Paper. The breakdown between our Fund's composition and the index's is as follows:

Investment Composition
Quantum Liquid Fund* Benchmark (Crisil Liquid Fund Index )**
CBLO - 10%CBLO (Call Money) - 15%
AAA PSU Commercial Paper - 21%Commercial Paper - 35%
Treasury bills - 35%-
Certificate Deposits - 34%Certificate of Deposits (CDs) - 50% (28% in private sector)
Treasury bills, Commercial Deposits, and AAA rated PSU Commercial Paper have low credit risk and low returns
* As on 29 July 2016, ** July 2016

Commercial Paper and Private Sector Certificates of Deposit usually generate 60 to 100 and 10 to 15 basis point more return than PSU bank Certificates of Deposit respectively. Due to the Quantum Liquid Fund's having lower exposure to these two types of papers, returns are 60 to 80 basis points lower than that of its peers.
We choose safety and liquidity over returns in the Quantum Liquid Fund and therefore our returns are lower than our benchmark and our peers.

To sum up, we would like to say that the main reason for investing in Liquid Funds should be the perceived safety and liquidity factors. These funds are most liquid and less volatile. There are different types of funds and they all have different purposes, so see which ones suit you and invest your hard-earned savings accordingly. Please consult your financial advisor before taking any investment related decision.

Above article is authored by Quantum.

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