liquid funds are considered one of the safest mutual fund categories. they invest in short-term instruments with maturities up to 91 days. treasury bills. commercial papers. certificates of deposit. the goal is capital preservation with quick access.
but safe does not mean risk-free. liquid funds can give negative returns. the conditions are rare. but they exist.
how liquid funds can lose value
credit events. the primary risk in a liquid fund is credit risk. if a company defaults on its commercial paper, the fund’s NAV can drop. this happened during the IL&FS crisis in 2018. liquid funds with exposure to IL&FS group companies had to mark down their NAV. investors saw negative returns.
market dislocation. a sector-specific issue can cause broader instability. after the IL&FS episode, institutional investors pulled money from liquid funds. the outflows created pressure. NAVs were affected. the impact was limited to certain funds with exposure to the affected companies.
technical glitches. the NSE closing price glitch in august 2026 affected mutual fund NAVs. funds using NSE closing prices for valuation saw NAV fluctuations. index funds and ETFs were impacted. the effect was short-term but real.
interest rate risk. bond prices move inversely to interest rates. liquid funds hold short-term instruments. the duration is low. the impact is limited. a sharp rise in interest rates can still cause a small negative return.
tracking error and volatility. a comparison of kotak liquid fund and uti liquid fund shows the extremes. kotak liquid fund had 3-year returns of +4.77% and volatility of 0.3%. uti liquid fund had 3-year returns of -51.39% and volatility of 89.8%. the maximum drawdown for kotak liquid fund was -0.0%. for uti liquid fund, it was -90.0%. this is an outlier. but it shows that liquid funds can lose significant value.
the risk of negative returns is low
liquid funds are designed for stability. they invest in high-quality short-term debt. the average maturity is around 72 days. the modified duration is similarly low. this minimizes the impact of interest rate changes.
the risk class for liquid funds is typically “relatively low interest rate risk and moderate credit risk”. this means the fund can lose value. but the probability is low.
when liquid funds give negative returns
a liquid fund gives negative returns when its NAV drops below its value at the start of the period. this is unusual. over a 6-month period, the worst performer in the category can show losses. one-year returns can be negative in extreme cases. for some funds, 5-year returns have also been negative.
what to watch for
credit quality. high-quality paper has lower credit risk. funds investing in AAA and A1+ rated instruments are safer.
portfolio composition. checking if the fund holds commercial paper of companies in stressed sectors. higher exposure to these companies increases risk.
diversification. funds with a wide spread across issuers are less vulnerable to a single default.
frequently asked questions
1. can liquid funds give negative returns
yes. liquid funds can give negative returns due to credit events, market dislocations, or technical glitches. the risk is low but not zero.
2. have liquid funds given negative returns in the past
yes. during the IL&FS crisis, some liquid funds with exposure to the group saw NAV declines.
3. are liquid funds risk-free
no. liquid funds are low risk. but they are not risk-free. credit risk and interest rate risk exist.
4. what is the worst-case return for a liquid fund
historical data shows that some liquid funds have had negative returns over 1-year and 3-year periods. returns as low as -51.39% over 3 years have been recorded for some funds.
5. are liquid funds safer than fixed deposits
liquid funds carry market risk. fixed deposits guarantee returns up to ₹5 lakh. for absolute certainty, fixed deposits are safer. for flexibility, liquid funds are better.
