Direct equity investors are increasingly embracing liquid exchange-traded funds (ETFs) to optimize their trading activity. Brokers are also encouraging clients to transfer unutilised funds into liquid ETFs. Their pitch is simple: rather than juggling money back and forth between the trading account and bank account, investors can park excess funds in liquid ETFs. So are equity trading and liquid ETFs a match made in heaven?
A marriage of convenience
In equity trading or investing, timing is critical. You need quick access to money to take advantage of any mispricing. But keeping idle surplus in the bank account is a low-yield proposition. This is where liquid ETFs step in.
There are two benefits of using liquid ETFs in trading. One, these can help you manage cash flows seamlessly, without missing a beat. Two, these allow more productive use of your idle money.
When you sell equity shares on an exchange, you may simultaneously purchase an equal amount of units of a liquid ETF via the broker. The liquid ETF units get credited in the demat account on T+1 day—the same day as the payout from proceeds of the share sale. Now, you can continue holding on to the liquid fund units till you are ready to redeploy. Your money will continue fetching returns via the liquid ETF rather than earning savings bank account interest.
When a buying opportunity arises, you can then sell the liquid ETF units. The money will be credited to your trading account with the broker the following day, but you can immediatelyly avail yourself of the limit to buy shares via your demat account. Essentially, liquid ETF units are equivalent to money in your trading account.
“This seamless experience is possible as liquid ETFs trade in the same segment as equities,” asserts Zerodha Fund House CEO Vishal Jain. In any other vehicle, including a liquid fund, the investor would have to wait for the payout to hit the bank account and transfer it back, which could result in lost opportunities.
HOW IT WORKS
1. When selling shares, simultaneously purchase liquid ETF units of equal amount.
2. Units get credited on T+1 day, along with payout from share sale.
3. Continue holding liquid ETF units until you redeploy.
4. When a buying opportunity arises, sell liquid ETF units.
5. Money gets credited on T+1 day, but you get a limit immediately to buy shares.
6. Additionally, liquid ETFs can be pledged to acquire margin for trading in F&O.
This solution works in favour of brokers as well. At present, every broker is mandated to transfer unutilised client funds back to the latter’s bank account at the end of each month. Liquid ETFs save brokers the hassle of carrying out monthly settlements while avoiding fund outflows and retaining assets in their fold. “It is a matter of convenience for both the investor and the broker. It is why many brokers are not charging for the buying and selling of liquid ETFs,” observes Juzer Gabajiwala, Director, Ventura Securities.
Additionally, you can pledge liquid ETF units held in your demat account to acquire margin for trading in the futures and options (F&O) segment. The margin received from liquid ETF holdings is treated as a cash equivalent by exchanges. “Many traders pledge units of liquid ETFs as collateral and take exposure against it,” says Zerodha’s Jain.
Liquid ETFs and equity trading
Key benefits
Liquid, but with a twist
But what are these liquid ETFs anyway? Unlike what the name suggests, liquid ETFs are not the same as liquid funds. Besides the fact that liquid ETFs are traded on exchanges in real-time, whereas liquid funds aren’t, there are other differences.
One, these invest differently. Liquid ETFs primarily invest in overnight securities, i.e., tri-party repos (TREPs), whereas liquid funds park money in instruments with maturity up to 91 days. Liquid funds levy a graded exit load if sold within seven days of purchase. Also, liquid ETFs charge no exit loads, offering liquidity without restrictions.
To be sure, liquid ETFs have been around for many years. Benchmark Mutual Fund’s Liquid BeES (now under Nippon India MF) was the first liquid ETF offering in the country in 2003. A few more came later. However, these funds were constrained by virtue of being income distribution-cum-capital withdrawal (IDCW) plans. Dividends are now taxed in the hands of the investor at his or her slab rate. This made traditional liquid ETFs tax inefficient. Further, in some liquid ETFs, the dividend payout accrued in the form of additional units and not cash payouts. This complicated the tax calculations for investors.
However, last year, Zerodha MF’s offering Nifty 1D Rate Liquid ETF marked the arrival of liquid ETFs with a growth NAV for the first time in India. Unlike the returns of IDCW liquid ETFs, the returns in the growth plans are reflected in their day-to-day NAV movement instead of dividend payouts. Only the gains are taxable when sold by the investor.
“Further, it removes the hassle of dividend accounting and tracking payouts, making it a simpler proposition for investors,” says Jain. Since Zerodha’s liquid ETF, several players have launched similar products. Many of these firms—AngelOne, Groww, Mirae, among others—have both stock broking and mutual fund arms.
What to watch for
Liquid ETFs can power your trades with a seamless experience. These allow you to earn better returns while maintaining liquidity. There is negligible credit risk and interest rate risk in liquid ETFs, making them a safe option to park money.
However, investors in liquid ETFs can expect only money market-like returns. According to Value Research, open-ended liquid funds have yielded 7.28% in the past year. Meanwhile, liquid ETFs have averaged 6.1%, similar to overnight funds’ 6.4%. Yet, this is better than earning a bank savings account interest rate of 3% or even lower. “A liquid ETF is not comparable to a liquid fund. It is akin to an overnight fund. Use it for the convenience it offers in trading, not for returns,” remarks Gabajiwala.
Prominent liquid ETF offerings
Further, liquid ETFs charge relatively higher expense ratios, averaging 31 basis points compared to liquid funds’ 15 basis points. Other exchange and statutory levies also apply, even if liquid ETFs are not subject to securities transaction tax (STT). Also, make sure to pick liquid ETFs supported with high trading volumes, or else liquidity will only turn out to be illusory.
A marriage of convenience
In equity trading or investing, timing is critical. You need quick access to money to take advantage of any mispricing. But keeping idle surplus in the bank account is a low-yield proposition. This is where liquid ETFs step in.
There are two benefits of using liquid ETFs in trading. One, these can help you manage cash flows seamlessly, without missing a beat. Two, these allow more productive use of your idle money.
When you sell equity shares on an exchange, you may simultaneously purchase an equal amount of units of a liquid ETF via the broker. The liquid ETF units get credited in the demat account on T+1 day—the same day as the payout from proceeds of the share sale. Now, you can continue holding on to the liquid fund units till you are ready to redeploy. Your money will continue fetching returns via the liquid ETF rather than earning savings bank account interest.
When a buying opportunity arises, you can then sell the liquid ETF units. The money will be credited to your trading account with the broker the following day, but you can immediatelyly avail yourself of the limit to buy shares via your demat account. Essentially, liquid ETF units are equivalent to money in your trading account.
“This seamless experience is possible as liquid ETFs trade in the same segment as equities,” asserts Zerodha Fund House CEO Vishal Jain. In any other vehicle, including a liquid fund, the investor would have to wait for the payout to hit the bank account and transfer it back, which could result in lost opportunities.
HOW IT WORKS
1. When selling shares, simultaneously purchase liquid ETF units of equal amount.
2. Units get credited on T+1 day, along with payout from share sale.
3. Continue holding liquid ETF units until you redeploy.
4. When a buying opportunity arises, sell liquid ETF units.
5. Money gets credited on T+1 day, but you get a limit immediately to buy shares.
6. Additionally, liquid ETFs can be pledged to acquire margin for trading in F&O.
This solution works in favour of brokers as well. At present, every broker is mandated to transfer unutilised client funds back to the latter’s bank account at the end of each month. Liquid ETFs save brokers the hassle of carrying out monthly settlements while avoiding fund outflows and retaining assets in their fold. “It is a matter of convenience for both the investor and the broker. It is why many brokers are not charging for the buying and selling of liquid ETFs,” observes Juzer Gabajiwala, Director, Ventura Securities.
Additionally, you can pledge liquid ETF units held in your demat account to acquire margin for trading in the futures and options (F&O) segment. The margin received from liquid ETF holdings is treated as a cash equivalent by exchanges. “Many traders pledge units of liquid ETFs as collateral and take exposure against it,” says Zerodha’s Jain.
Liquid ETFs and equity trading
Key benefits
- No transfer hassles: Does away with transferring idle funds between trading accounts and bank accounts.
- Equivalent to cash: Enables seamless transition from equities to cash and vice versa.
- Earn more on idle money: Fetch higher returns on unutilised funds than bank savings accounts.
- Not akin to liquid funds.
- Returns are similar to overnight rates.
- These levy higher expense ratios than liquid funds.
- No STT and brokerage levied, but exchange and statutory levies will apply.
- Low trading volumes in some liquid ETFs.
Liquid, but with a twist
But what are these liquid ETFs anyway? Unlike what the name suggests, liquid ETFs are not the same as liquid funds. Besides the fact that liquid ETFs are traded on exchanges in real-time, whereas liquid funds aren’t, there are other differences.
One, these invest differently. Liquid ETFs primarily invest in overnight securities, i.e., tri-party repos (TREPs), whereas liquid funds park money in instruments with maturity up to 91 days. Liquid funds levy a graded exit load if sold within seven days of purchase. Also, liquid ETFs charge no exit loads, offering liquidity without restrictions.
To be sure, liquid ETFs have been around for many years. Benchmark Mutual Fund’s Liquid BeES (now under Nippon India MF) was the first liquid ETF offering in the country in 2003. A few more came later. However, these funds were constrained by virtue of being income distribution-cum-capital withdrawal (IDCW) plans. Dividends are now taxed in the hands of the investor at his or her slab rate. This made traditional liquid ETFs tax inefficient. Further, in some liquid ETFs, the dividend payout accrued in the form of additional units and not cash payouts. This complicated the tax calculations for investors.
However, last year, Zerodha MF’s offering Nifty 1D Rate Liquid ETF marked the arrival of liquid ETFs with a growth NAV for the first time in India. Unlike the returns of IDCW liquid ETFs, the returns in the growth plans are reflected in their day-to-day NAV movement instead of dividend payouts. Only the gains are taxable when sold by the investor.
“Further, it removes the hassle of dividend accounting and tracking payouts, making it a simpler proposition for investors,” says Jain. Since Zerodha’s liquid ETF, several players have launched similar products. Many of these firms—AngelOne, Groww, Mirae, among others—have both stock broking and mutual fund arms.
What to watch for
Liquid ETFs can power your trades with a seamless experience. These allow you to earn better returns while maintaining liquidity. There is negligible credit risk and interest rate risk in liquid ETFs, making them a safe option to park money.
However, investors in liquid ETFs can expect only money market-like returns. According to Value Research, open-ended liquid funds have yielded 7.28% in the past year. Meanwhile, liquid ETFs have averaged 6.1%, similar to overnight funds’ 6.4%. Yet, this is better than earning a bank savings account interest rate of 3% or even lower. “A liquid ETF is not comparable to a liquid fund. It is akin to an overnight fund. Use it for the convenience it offers in trading, not for returns,” remarks Gabajiwala.
Prominent liquid ETF offerings
Further, liquid ETFs charge relatively higher expense ratios, averaging 31 basis points compared to liquid funds’ 15 basis points. Other exchange and statutory levies also apply, even if liquid ETFs are not subject to securities transaction tax (STT). Also, make sure to pick liquid ETFs supported with high trading volumes, or else liquidity will only turn out to be illusory.
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