I'm trying to understand the differences between overnight funds and a bank savings account or fixed deposit in terms of safety. These are both common ways to park money for short periods.
I know that overnight fund is a kind of debt fund where the debt instruments mature overnight. But there are still a number of things that are unclear to me about it.
My major concern is safety of the principal. But to determine safety, it's helpful to know exactly what is being done with the money. As the saying goes: what you don't know can hurt you. And also, the devil is in the details. (The latter is a saying I really like.)
Traditionally, the standard way in India to hold money is in a savings account or FD. However, savings accounts/fixed deposits in India are not safe. Indian deposit insurance is among the lowest in the world. It was until recently 1 lakh per account, and I believe that this has recently been increased to 5 lakhs in light of the PMC debacle. This is in contrast to USD 250,000 for the USA, and Euro 100,000 for the EU. Also, my understanding is that in the case of bank failure, even this amount will not be made available immediately, but only once the bank is liquidated, which may take years.
Since deposit insurance is so grossly inadequate, in case a bank runs into trouble, it needs to get help from the govt. But cooperative banks fail all the time, and the govt does nothing to help them. PMC is just the largest of such events, so made the news in a way that the others did not. However, the govt apparently sees nothing wrong with allowing thousands of unsafe cooperative banks to continue functioning, nor does it try to protect the public in any way from the possible consequences of failure. For example, it has never, to my knowledge, ever issued any safety warnings about banks. So an obvious defensive ploy is to only keep money in banks that are large enough that the govt will be compelled to bail it out. The so-called "To Big To Fail" banks. I checked, and apparently SBI, HDFC, and ICICI currently fall into that category. But it would be really nice not to have to depend on a bail out in the event of a problem.
In light of the above, the idea of an overnight fund seems quite appealing. But it's a good idea to take a long and hard look at it first.
The article https://www.livemint.com/money/personal-finance/five-ways-in-which-debt-funds-score-over-fix-deposits-fds-11573373387893.html is one of the few places where I found a discussion of comparative risks. The author writes:
Unlike debt funds, the risk of concentration is high in investments like fixed deposits where investors hold large sums of money and run the risk of losing it all if things go wrong. There is very little information available to investors that they can use to evaluate their investments and they have very few options for exit or redressal.
Open-ended funds, on the other hand, are required to provide regular information on portfolio and performance to investors and can exit at the current value of the units at any time.
So the author is saying that if one has an account with ICICI, for example, all ones risk is concentrated in one bank/company.
It's ironical he should mention information on portfolios, because my question is largely about the overnight fund portfolios.
In many places, overnight funds are mentioned as an alternative to bank deposits (savings account or fixed deposit. But it's not clear to me how the respective risks compare. I'm also still not clear what the risk of a overnight fund is, exactly. It's described in various places as "low risk", but I'm not sure what that translates to in concrete terms.
I know that debt funds in general list their portfolio, so one should look at that for more details. However, looking at this hasn't been particularly enlightening. I looked at some overnight funds (sample list).
The SBI fund is the oldest, apparently having begun on October 01, 2002
All the overnight fund portfolios I've looked at have the following in various proportions, but nothing else: Reverse Repo, Net Receivables, TREPS. Usually one of these three is dominant.
For example, the SBI overnight funds breaks down as follows:
Reverse Repo (sometimes just Repo) 99.10% Net Receivables 0.63% TREPS 0.27%
I'm not completely sure what any of these terms mean. Here are some guesses.
Reverse Repo/Repo: This is vague. Repo is short for repurchase agreement. Repo and Reverse repo are general terms, but it's possible it is being used in a specific sense in this case. The general sense is that some entity (possibly a central bank) sells a bond to the overnight fund for an overnight people, and then buys it back the next day at a higher price, i.e. the original price plus interest. In other words, the entity is borrowing money overnight from the overnight fund.
In this case, it's possible that the entity is the RBI, but this is just a guess. It might be others. And digging around in the records of overnight funds revealed no additional details. If the entity that the overnight fund is doing business with is exclusively the RBI, then an obvious question then is - is the RBI willing to sell as many bonds as the overnight fund wants?
TREPS: This appears to correspond to something called a Triparty Repo (https://www.ccilindia.com/FAQ/Pages/TREPS.aspx), which is a repo contract using a third party as intermediary. Would this third party hold collateral? It's not clear. It's also not clear how this differs from Repo/Reverse repo. Does Repo/Reverse repo not involve a third party?
I found the Wikipedia Repurchase agreement article helpful when trying to understand what repurchase agreements are.
Net Receivables: I'm not currently sure what this is. But a search bought up this question on tradingqna.com, https://tradingqna.com/t/net-receivables-in-mutual-funds/70428/5 but I didn't find the answers there convincing.
Finally, this might be a dumb question, but what is stopping an individual doing what these funds are doing?