It’s the season of Initial Public Offerings, and Indian stock markets are brimming with activity. Do you want to trade actively and execute well-timed transactions when a lucrative trading opportunity presents itself? But do you also not want your money to remain idle in a margin account while you wait around for that opportunity to come?
Liquid ETFs or Exchange Traded Funds can be the cash and liquidity management tool that you are looking for. These ETFs can help optimize returns during stock market trading. Here’s how.
When you sell stocks, the stocks get debited from your DEMAT account and the net sale proceeds are credited to your margin account on T+1 day. Then you either remit your money to your bank account or let it lie idle in your margin account till you find the next buying opportunity. If you have transferred the funds to your bank account, you would have to transfer it back to your margin account at the time of the next purchase of shares which is time-consuming and inefficient. If you let the funds sit in your margin account to enable you to make timely trades, you risk losing out on earning bank interest.
Instead, if you sell a scrip and simultaneously buy equivalent units of a Liquid ETF, stocks would get debited from your DEMAT account and units of the liquid ETF would get credited. You will then earn a daily return on your liquid ETF holdings till you decide to do your next stock purchase. When a buying opportunity arises, you can buy the shares by selling the liquid ETF units, making them equivalent to money in margin account and thus making timely trades possible.
Liquid ETFs majorly invest in Tri-party repos and also other money market instruments. Tri-party Repo i.e. TREPS facilitates borrowing and lending of funds in a Triparty Repo arrangement.TREPS settlement is guaranteed by Clearing Corporation of India Ltd.Liquid ETFs aim to provide returns that before expenses closely correspond to the returns of S&P BSE Liquid Rate index or the Nifty 1D Rate index, subject to tracking errors. These indices use the “Tri-Party Repo on Government Securities or T-bills” overnight rate for computation of index values.
The daily return is declared in the form of Income Distribution cum Capital Withdrawal or IDCW, which includes both dividends and capital gains made by the scheme portfolio. IDCW declared daily can be in the form of additional ETF units or dividend, which are compulsorily reinvested in the Scheme.
Units arising out of IDCW reinvestment are extinguished and paid out to the investors on a weekly or monthly basis. Any suchdividend paid is added to the investor’s income and taxed at the slab rate applicable.
Units of Liquid ETFs are listed on the exchanges and can be bought and sold like shares during market hours. Liquid ETFs are widely used by large retail traders, High Net Worth investors, institutional investors like Portfolio Management Services providers, Futures & Options brokers. This results in ample liquidity of these instruments on the exchanges. Trading in Liquid ETFs does not attract Securities transaction Tax, so you don’t have to worry about paying up for frequent buying and selling.
In addition to being extremely liquid and earning low but stable returns, Liquid ETFs are relatively safe with no interest rate risk and low credit risk. Since these ETFs invest in Tri-party repos which are overnight instruments, interest rate risk is absent. Also, since the eligible securities in Tri-party repos are mostly government securities, credit risk is limited.
While choosing a Liquid ETF, one should look out for ETFs with reasonably large trading volumes to enable exit at fair prices, low expense ratios to maximize returns and low tracking errors to minimize deviation from underlying index.
Liquid ETFs can offer stock market investors the proverbial best of both worlds –potential to earn returns on idle funds and ready liquidity to make the most of attractive equity market opportunities.