Investors usually focus a lot on their investment returns but overlook some other aspects that can help deploy excess funds better and earn a few extra bucks. One such case is the trading account balance. Many investors have funds in their trading accounts (either as gains on the sale of stocks or as added capital) to meet margin requirements, especially for derivatives. In such cases, we find that the funds in the trading account are inactive. What if there is a way to earn interest on this otherwise unused money, and if it is also available for deployment should an investment opportunity arise? Enter Liquid BeES / Liquid ETFs.
What are liquid ETFs?
BeES/Liquid ETFs are exchange-traded funds that are traded on the secondary market like stocks. These funds invest in money market instruments, overnight cash, low risk overnight securities and guarantee reduced risk and liquidity. Liquid ETF returns are in the range of 3-4% per annum and dividends are credited daily, which are reinvested in the form of additional units credited to the demat account once every 30 days. It should be noted that, given their liquidity, most brokers accept these units as cash equivalents and extend margins against them.
Advantages of liquid ETFs
Liquid ETFs are a very good avenue for parking funds. They can be liquidated at any time on the markets. In addition, these funds offer an annual return of 3-4%, as mentioned above. The liquid ETF attracts brokerage but has no STT (Securities Transaction Tax), custody and transaction fees. Thus, the transaction cost is relatively economical. Shares of the funds can be purchased easily from its trading account. Liquid ETFs may support margin requirements for derivatives trading (especially options trading which requires margin when writing) when pledged with your broker.
Liquid ETFs have lower expense ratios and are therefore relatively cheaper. For example, the Nippon India Nifty 1 Day Rate Liquid BeES ETF as well as the DSP NIFTY 1D Rate Liquid ETF change an expense ratio from 0.64 to 0.67%.
Optimization of use
Investors can check out these funds to enhance their overall returns without compromising their trading requirements. These funds, traded on secondary markets, have high liquidity and can therefore be converted into cash almost instantly. The settlement process in the market is T+2 days and therefore the units will be credited on the day of settlement. Once the units are credited, the daily dividends will be credited in the form of additional units and will therefore generate additional income when idle and can be pledged when funds are needed for derivative transactions.
Liquid ETFs attract an 8-12% discount (on Zerodha, for example) on pledges and the margin so received is considered 100% cash equivalents, which meets margin requirements for trading derivatives.
Let’s analyze an example.
Jaidev has ₹1,00,000 in his demat account and is looking for an opportunity to invest. Instead of leaving idle cash in the trading account, he buys liquid ETFs worth that amount and receives a daily dividend in the form of additional units. A few days later, he decides to sell Nifty 17800 CE (end of month expiry) and the margin requirement is ₹1,05,552. Jaidev now pledges his liquid fund units and gets a margin worth ₹92,000 after taking an 8% discount and the remaining ₹13,000 is paid out as well. Now Jaidev closes the deal after 12 days and makes a profit of ₹11,090 and releases his units from the pledge.
Things to watch out for
Since units also include daily dividends, there also happen to be fractional units that cannot be sold on the open markets. Generally, the issuing fund house redeems these fractional units through an off-market transfer mechanism. Another aspect that investors should keep in mind is the applicable brokerage fees, although liquid ETFs do not charge STTs or transaction fees. Investors should also consider the angle of taxation, dividends received will be taxed as income from other sources at the applicable slab rate while income on the transfer of liquid ETFs will be taxed as capital gains. As liquid ETFs are essentially debt funds, if the holding period is less than 36 months, they will be taxed as short-term capital gains at 15% (or applicable rates); otherwise, it will be taxed as long-term capital gains at 20 percent with indexation benefit. Investors should consider these aspects before investing in liquid ETFs.
September 17, 2022