Best Liquid Funds 2025

What are Liquid Funds?

Liquid Funds are a type of debt mutual fund. These funds pool money from investors to invest in debt and money market securities like Commercial Paper (CP), Treasury Bills (T-Bills), Certificate of Deposits (CDs), etc. 

To give you context, corporate and government organisations issue commercial paper and treasury bills, respectively, to meet short-term funding needs. Liquid funds invest in these short-term securities that mature in a very short period, typically a maximum of up to 91 days.

This means that a liquid fund manager invests only in securities where the borrower promises to repay the principal investment and interest within 91 days. Additionally, liquid funds process redemption requests within one working day (T+1), providing investors with quick access to their funds.

Why are these Funds called ‘Liquid Funds’?

The term ‘Liquid’ in finance reflects how easily an asset can be converted to cash without any loss in its value. Since liquid funds invest in securities that mature within 91 days, these are considered very low risk and almost as good as holding cash. 

Investors can access their money almost immediately when needed, and there is a negligible loss in value. Liquid funds are built to provide a combination of safety and flexibility, making them ideal for short-term investments or parking surplus cash temporarily. 

How do Liquid Funds work?

Before we understand how liquid funds work, let’s first understand the core concept of this process. Imagine you run a business where customers pay for their orders 30 days after delivery. 

However, to keep the business running smoothly, you need funds right away to pay your employees and purchase raw materials for your next batch of products.

To bridge this gap, you issue a short-term borrowing instrument called a Commercial Paper (CP), which promises to repay the loan within 30 days, along with a small amount of interest.

A liquid mutual fund manager sees this as a great opportunity. Since your business is financially stable and the payment from your customers is almost guaranteed within 30 days, the risk of default is very low. 

The fund manager pools money from investors and purchases your CP, providing you with the funds you need. When your customers pay you after 30 days, you repay the CP along with the interest. The liquid fund earns interest and passes the returns to its investors.

This is how liquid funds work. They invest in short-term debt instruments like CPs, treasury bills, and certificates of deposit that typically mature within 91 days, ensuring low risk and steady returns for investors.

What kind of debt securities do Liquid Funds invest in?

Liquid funds invest in short-term, high-quality debt securities that are designed to provide liquidity and low risk. When a company borrows funds on a short-term basis, it issues commercial paper. Similarly, when the Government borrows funds, it issues a treasury bill.

When fund managers invest in debt instruments, they maintain strict checks to ensure that credit risk is as low as possible. They usually focus on instruments that have a high credit rating (AAA or AA+). These ratings indicate that the issuer has a very low likelihood of default.

Another important thing that every fund manager ensures is to diversify these debt instruments across T-Bills, CDs, and CPs from different sectors and issuers to reduce the concentration risk.

In conclusion, liquid funds focus on investing in safe and high-quality debt instruments to ensure liquidity and low credit risk. By employing rigorous checks and investing in government-backed securities, liquid funds try to deliver stable returns while protecting investors’ capital.