<p dir="ltr">While you might have heard a lot about the common risks of <a href="https://www.utimf.com/articles/how-to-invest-in-mutual-funds/">investing in mutual funds</a>, risk due to liquidity is rarely talked about. Read on to know what it is and why it is so important for every investor.</p>
<p dir="ltr">If you're new to <span><a href="https://www.utimf.com/articles/mutual-funds-basics/">mutual funds</a></span> and still educating yourself, you might have come across a lot of information about the common risks. From market volatility, interest rate risk, credit risk, concentration risk, there are a lot of things that you should know about before you start your investment. But while you may easily come across articles and blogs talking about these common risks, not a lot of them talk about the risk of liquidity in mutual funds.</p>
<p dir="ltr">When investing in mutual funds, liquidity risk is often ignored. Liquidity risk is when the investor cannot liquidate their investments at will. When it comes to types of liquidity risk, the risk can be due to the nature of the scheme, like close-ended schemes, fixed maturity plans, etc. or due to the quality of the investment portfolio, e.g. investment in illiquid securities.</p>
<p dir="ltr">Close-ended mutual fund schemes have a fixed maturity date, and the investors cannot redeem their investments through the fund house before the maturity date. While close- ended schemes are also listed on stock exchanges, the liquidity for the mutual fund units may not be adequate for the investors to sell the units at a fair value.</p>
<p dir="ltr">In contrast, open-ended mutual fund schemes are often liquid, as the <strong>fund house ensures liquidity in mutual funds</strong>. The investors can place a redemption request within the cut-off timings, and the redemption proceeds are credited to the investor&#39;s bank account as per the regular processing cycle. However, in case of any adverse credit event like a rating downgrade of the portfolio security, the mutual fund house may not be able to liquidate the investments to generate cash, thereby leading to the liquidity risk for the mutual fund scheme.</p>
<p dir="ltr">As such, investors should always aim to invest in mutual fund schemes with high-quality portfolios, especially when it comes to debt funds.</p>
<p dir="ltr">If this is the first time that you&#39;re reading about the risks due to liquidity in mutual funds, here are some of the most important things you should know-</p>
<h2 style="font-size:21px"><strong><span>1. How do AMCs ensure liquidity?</span></strong></h2>
<p dir="ltr">There are different ways in which an AMC tries to keep liquidity risk at a minimum. For instance, many AMCs hold adequate cash positions to keep up with the daily transactions of the fund.</p>
<p dir="ltr">Also, the AMCs try to maintain a healthy balance between the inflow and outflow of funds to avoid any kind of risks due to liquidity. Redeeming matured bonds and reinvesting interest and dividends are two other ways for ensuring adequate liquidity.</p>
<h2 style="font-size:21px"><strong><span>2. Types of funds more prone to liquidity risk</span></strong></h2>
<p dir="ltr">There may be many different causes of liquidity risk, but the most common reason is when a mutual fund invests in securities that are not easily or frequently traded on exchanges. In such cases, an AMC might incur a substantial cost for converting these securities into cash.</p>
<p dir="ltr">While most mutual funds in India are liquid, there are a few types of funds that are more prone to risk as compared to others. For instance, close-ended credit-risk funds often have a higher risk as the chances of default are high. Also, funds that invest in low-quality bonds are at risk too.</p>
<p dir="ltr"><span>When selecting mutual funds, especially <a href="https://www.utimf.com/mutual-fund-products/debt-funds/">debt funds</a>, make sure that you check the portfolio of the fund to pick safer funds.</span></p>
<h2 style="font-size:21px"><strong><span>3. Buy-Back from Fund House </span></strong></h2>
<p dir="ltr">As per SEBI regulations, every close-ended scheme shall be listed in a recognized stock exchange within six months from the closure of the subscription. Repurchase of close-ended schemes: Units of a close-ended scheme, other than those of an equity-linked savings scheme, shall not be repurchased before the end of the maturity period of such scheme. The units of close-ended schemes as referred above may be open for sale or redemption at fixed predetermined intervals, if the maximum and minimum amount of sale or redemption of the units and the periodicity of such sale or redemption have been disclosed in the offer document.</p>
<p dir="ltr">Most AMCs rarely provide buy-back offers and prefer listing the fund on an exchange. But due to lack of buyers and sellers, the liquidity risk remains. </p>
<h2 style="font-size:21px"><strong><span>4. Fluctuations in NAV</span></strong></h2>
<p dir="ltr">Ever saw the price of a stock that is not regularly traded on the exchange? It may be highly volatile and change significantly with every buy or sell order. The same is true for a fund struggling with liquidity.</p>
<p dir="ltr"><span>The liquidity pressure makes such funds riskier and they often experience higher NAV changes on a regular basis. This makes </span>liquidity risk management so crucial for mutual funds. </p>
<h2 style="font-size:21px"><strong><span>5. How investors may avoid the risk due to liquidity?</span></strong></h2>
<p dir="ltr"><span>Investors need to understand the tenure of the close-ended schemes before making an investment decision. If the investor decides to invest in a close-ended mutual fund, the investor should make sure the close-ended scheme is aligned to his/her financial objectives. </span></p>
<p dir="ltr"><span>The fund should be regularly traded on the exchange with decent trade volumes. It should not have junk bonds or highly risky credit instruments in the portfolio. </span></p>
<h2 style="font-size:21px"><strong><span>Conclusion</span></strong></h2>
<p dir="ltr">While mutual fund liquidity is not quite a significant concern for most types of funds, you should be extra cautious if you&#39;re planning to invest in close-ended funds.</p>
<p dir="ltr"><span>A lot of times the negative impacts of the liquidity risk come announced, making it very important for the investors to closely track the performance of these funds if they do decide to invest in them. </span></p>
<p dir="ltr"><span><strong>DISCLAIMER</strong>:</span></p>
<p dir="ltr"><strong>Mutual Fund investments are subject to market risks, read all scheme related documents carefully.</strong></p>
<p dir="ltr">To know about the KYC documentary requirements and procedure for change of address, phone number, bank details, etc. please visit https://www.utimf.com/servicerequest/kyc. Please deal with only registered Mutual funds, details of which can be verified on the SEBI website under &quot;Intermediaries/market Infrastructure Institutions&quot;. All complaints regarding UTI Mutual Fund can be directed towards service@uti.co.in and/or visit www.scores.gov.in (SEBI SCORES portal). This material is part of Investor Education and awareness initiative of UTI Mutual Fund.</p>