Ultra Short Term Funds

Ultra Short-Term Mutual Funds are ideal for investors seeking a low-risk, short-term investment option, typically for periods of 91 days or less. These funds provide liquidity, stability, and better returns than savings accounts, making them a practical cash management solution.
EXPLORE FUNDS
What are Ultra Short Term Mutual Funds
EXPLORE FUNDS
4 mins
30-December-2024

An ultra short term mutual fund is designed for investors seeking a low-risk option to park their money for a short duration, typically 91 days or less. Despite being characterised by a relatively low-risk profile attributed to their brief lending duration, these funds position themselves slightly above liquid funds in the risk spectrum. However, it is important to note that when we talk about different investment schemes, ultra short duration Funds maintain one of the lowest risk levels, making them a favourable choice for risk-conscious investors.

Let us understand what are ultra short mutual funds, features of ultra short mutual funds, how do ultra short mutual funds work, should you invest in ultra short mutual funds and much more.

What are ultra short term mutual funds?

Ultra short duration funds, commonly referred to as ultra short term mutual funds, are a specialised category of fixed-income debt schemes focusing on investments with short maturity periods, usually ranging from three to six months. These funds are tailored for investors seeking a balance between enhanced returns and controlled risk. While they aim to deliver slightly higher returns compared to traditional savings instruments like fixed deposits or savings accounts, they also ensure relatively lower risk levels when compared to longer-term debt funds. By allocating assets to short-duration instruments such as treasury bills, commercial papers, and certificates of deposit, ultra short duration funds provide liquidity and stability. Their versatility makes them ideal for those looking to park surplus funds for a brief period while earning better returns without significant exposure to market fluctuations, ensuring a steady and low-risk investment experience.

These funds invest in a portfolio of debt instruments and money market assets for durations ranging from a week to 18 months, making them an attractive option for investors seeking short-term investment opportunities. For individuals with surplus funds looking to park them for a brief tenure, ultra-short funds offer the advantage of earning dividends.

The investment strategy of ultra short term mutual funds involve allocating funds to debt securities and money market instruments, ensuring that the Macaulay Duration of the fund's portfolio falls between three and six months. These characteristics make such funds particularly appealing to conservative investors with a short investment horizon. Ideally suited for those aiming to achieve specific financial goals within a short timeframe, these funds typically deliver average returns ranging between 7% and 9%.

Features of ultra short term funds

Key attributes of an ultra short mutual fund:

  • Minimal risks: Designed as low-risk investment solutions, they primarily hold high-quality debt instruments and money market assets. These investments boast lower risk due to their strong credit quality.
  • Short duration: Their focus on brief investment periods sets them apart. Typically, the securities in these funds have maturities ranging from 3 to 6 months. This shorter timeframe mitigates the impact of interest rate fluctuations while ensuring stability, contrasting with funds with longer investment horizons.
  • Returns: Despite their conservative nature, these mutual funds aim for slightly higher returns than traditional savings accounts. These returns predominantly stem from interest income generated by the underlying securities, along with potential capital appreciation.

How do ultra short funds work?

An ultra short mutual fund manager constructs the fund’s portfolio by strategically selecting money market instruments and short-term debt investments. The manager focuses on securities with maturities that align with the fund's investment strategy, ensuring the portfolio maintains an average weighted maturity, or Macaulay duration, within the range of three to six months. This disciplined approach helps balance liquidity, stability, and returns, making the fund suitable for short-term investment goals. By carefully analysing credit quality, interest rate trends, and market conditions, the manager aims to optimise returns while minimising risk. The focus on short-duration securities not only limits exposure to interest rate fluctuations but also ensures the fund remains a low-risk option for investors seeking to park their funds for a brief period. This meticulous portfolio construction process is key to achieving the fund’s objectives of delivering stable returns and maintaining lower risk levels.

Advantages of investing in ultra short funds

  1. Lower Interest Rate Risk: Ultra short duration funds invest in debt instruments with relatively short maturities, reducing their sensitivity to interest rate fluctuations. This makes them less susceptible to interest rate risk compared to longer-term debt funds.
  2. Potential for Better Returns Than Traditional Savings Instruments: These funds aim to provide returns higher than traditional savings instruments such as fixed deposits and savings accounts. While they are not entirely risk-free, their short-term nature allows for a potential balance between safety and returns.
  3. Liquidity and Flexibility: Ultra short term funds offer liquidity as investors can typically redeem their units quickly. This feature is beneficial for those who may need access to their funds on short notice or want to capitalise on market opportunities.
  4. Suitability for Short-Term Goals: These funds are well-suited for conservative investors with a short investment horizon of three months to a year. They can be an ideal choice for individuals looking to meet specific financial goals within a relatively short time frame.
  5. Diversification of Portfolio: Ultra short duration funds often diversify their portfolios across a range of debt and money market instruments. This diversification helps mitigate risk and enhance the overall stability of the fund.

Also read: What Is Compound Annual Growth Rate (CAGR)

Why should you invest in ultra short funds?

Investing in ultra short funds offers a low-risk option for those seeking better returns than traditional savings instruments over a short period. These funds focus on short-maturity debt securities, typically ranging from three to six months, reducing interest rate sensitivity. They provide liquidity, making them ideal for parking surplus funds or meeting short-term financial goals. Additionally, ultra short funds ensure stability by investing in high-quality instruments, minimising default risk. Their potential to generate higher returns compared to savings accounts or fixed deposits, coupled with tax efficiency on long-term gains, makes them an attractive choice for conservative investors seeking stability and flexibility.

Who should invest in ultra short funds?

Ultra short term mutual funds are well-suited for a specific category of investors, primarily those with a conservative risk appetite and a strategic investment horizon. The ideal investor profile for ultra short funds includes individuals who can commit to remaining invested for a minimum period of three months, extending up to one year. It is crucial to understand that despite their conservative nature, ultra-short duration funds do not guarantee capital safety or assured returns.

Investors considering these funds should be comfortable with the potential for daily or weekly volatility in the market. While these funds may exhibit short-term fluctuations, the probability of incurring losses decreases with a longer investment horizon beyond three months. However, it is important to note that if the investment horizon extends to a year or longer, alternative investment options might be more suitable, and investors should carefully evaluate their financial objectives and risk tolerance before opting for ultra-short funds.

Importance of ultra short-term funds in investment portfolios

Ultra short-term funds play a crucial role in investment portfolios by offering liquidity, stability, and low-risk returns, making them ideal for short-term financial needs. They act as a buffer against market volatility by focusing on short-maturity debt instruments, ensuring steady performance even during fluctuating interest rate environments. These funds provide better returns than traditional savings accounts while maintaining lower risk compared to long-term debt funds. As part of a diversified portfolio, they help balance overall risk and returns, serving as a parking option for surplus funds. Their tax efficiency further enhances their importance for conservative and tactical

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Risks involved while investing

While considered low risk, ultra short term funds are not entirely risk-free. Interest rate fluctuations and credit risk can impact returns. Investors should carefully assess the credit quality of the fund's portfolio.

Taxation of ultra short term funds

The tax treatment of Ultra Short Term Funds varies based on the duration of the investment. Ultra-short-term mutual funds allocate more than 65% of their investible assets to debt instruments, categorising them as non-equity investments for tax purposes.

Capital gains from units held for less than three years or 36 months are considered short-term capital gains, attracting taxation at the investor's applicable income tax slab rate.

  • For investments held in ultra short duration schemes for three years or longer, the gains enjoy the benefits of long-term capital gains taxation.
  • If the investment was made on or before March 31, 2023, long-term gains are taxed at 20% with the advantage of indexation benefits.
  • For investments made on or after April 1, 2023, long-term capital gains from ultra short duration funds are taxed according to the investor's income tax slab rate for the relevant financial year, without the benefit of indexation.

Criteria for selecting good ultra short-term funds

  • Portfolio quality: Focus on funds that invest in high-quality debt instruments with minimal default risk.
  • Macaulay duration: Ensure the fund maintains an average maturity period of 3-6 months for stability.
  • Expense ratio: Opt for funds with a low expense ratio to maximise returns.
  • Historical performance: Evaluate consistent returns over various market cycles.
  • Liquidity: Check the ease of redemption to meet short-term financial needs.
  • Risk management: Assess the fund's credit and interest rate risk management strategies.
  • Fund manager expertise: Choose funds managed by experienced professionals with a strong track record.

Selecting a good ultra short-term fund involves evaluating multiple factors to ensure it aligns with your investment goals. Start by examining the fund’s portfolio quality, focusing on high-grade debt instruments to minimise risk. The fund's Macaulay duration, typically 3-6 months, ensures stability while balancing returns. Consider the expense ratio, as lower costs directly enhance profitability. Historical performance helps gauge the fund's ability to deliver consistent returns across market conditions. Liquidity is critical for meeting short-term goals, so ensure easy redemption options. Lastly, experienced fund managers with effective risk management strategies can significantly enhance the fund's performance and reliability.

Factors to be considered while investing in ultra short duration funds

  1. Investment Tenure: Ultra Short Term Mutual Funds are designed for short to intermediate-term investments. Consider aligning your investment tenure with the fund's duration, typically ranging from three months to a year. Assess your financial goals and liquidity needs before choosing the appropriate investment duration.
  2. Low Expense Ratio: Evaluate the expense ratio of the fund, as a lower expense ratio contributes to higher returns for investors. Look for funds with competitive expense ratios, ensuring that the costs associated with managing the fund do not significantly eat into your overall returns.
  3. High Credit Quality: Investors often assume that ultra-short duration funds carry no risk. While these funds indeed feature low interest rate risk, it is essential to recognise the presence of credit risks. Credit risk can lead to a permanent reduction in your investment. To mitigate this risk, prioritise funds with a high credit quality, indicating substantial allocations to AAA/A1+ rated papers. Monthly fund factsheets provide insights into a scheme's credit quality, allowing you to make informed investment decisions.In the pursuit of safety and stability in the underlying assets of ultra-short duration funds, it becomes crucial to assess the credit quality of the securities within the fund's portfolio. This emphasis on high-quality debt instruments helps minimise the potential risk of default, providing investors with greater confidence in the overall safety of their investments.
  4. Do Not Select a Scheme Based on Short-Term Performance: When choosing a scheme, refrain from relying solely on short-term performance indicators. Bond yields are subject to fluctuations due to macro-economic conditions, RBI's monetary policy, exchange rates, and various market-related factors. Forming return expectations based on short-term performance can be misleading. Additionally, a scheme may appear to offer higher returns by assuming greater credit risks. It is crucial to consider multiple factors, including risk assessment, personal risk tolerance, investment horizon, credit quality of the scheme, expense ratio, and more, to make well-informed investment decisions.
  5. Performance Track Record of the fund manager or fund house: Research the track record of the fund manager and the overall reputation of the fund house. A consistent and experienced fund manager is more likely to make sound investment decisions, contributing to the fund's performance. Similarly, opt for funds managed by reputable fund houses known for their ethical practices and transparent operations.

How to invest in ultra short term mutual funds on the Bajaj Finserv Mutual Funds platform

A step-by-step guide to invest in mutual funds

Step 1: Visit the Bajaj Finserv website or download the app from Google Play Store or App Store

Step 2: Navigate to 'Investments' and click on 'All Investments' on the home page

Step 3: Click on 'Mutual Funds' icon

Step 4: Click on 'Explore Funds'. You will be redirected to the mutual funds listing page

Step 5: Filter by scheme type, risk appetite, returns, etc. or choose from the top performing funds list

Step 6: All the mutual funds of the particular category will be listed, along with the minimum investment amount, annualised return, and rating

Step 7: Click on 'Invest Now'

Step 8: Enter your mobile number and sign in using the OTP

Step 9: Verify your details using your PAN, date of birth. If your KYC is not complete, then you will have to upload your address proof and record a video

Step 10: Enter your bank account details

Step 11: Upload your signature and provide some additional details to continue

Step 12: Choose and select the mutual fund that you want to invest in

Step 13: Choose whether you want to invest as SIP or lumpsum and enter the investment amount. Click on ‘Invest Now’

Step 14: Select your payment mode i.e., net banking, UPI, NEFT/ RTGS

Step 15: Once your payment is done, the investment will be complete

Your investment will start reflecting in your portfolio within 2-3 working days.

Ultra short-term funds vs liquid funds

Ultra short term funds and liquid funds are both low-risk investment options catering to short-term financial needs. While liquid funds primarily invest in debt instruments with maturities up to 91 days, ultra short term funds focus on securities with slightly longer durations, typically 3-6 months. This difference impacts their risk-return profile, with ultra short term funds offering higher potential returns but marginally more risk. Liquid funds are ideal for immediate liquidity, making them suitable for emergency funds, whereas ultra short term funds are better suited for slightly longer investment horizons.

Feature

Ultra Short Term Funds

Liquid Funds

Maturity

3-6 months

Up to 91 days

Risk Level

Low, but slightly higher than liquid funds

Very low

Returns

Higher than liquid funds

Lower but stable

Ideal for

Parking funds for 3-6 months

Immediate liquidity needs

Portfolio

Short-term debt instruments and money market securities

High-quality short-term debt instruments

Liquidity

Moderate liquidity; may have exit loads for early withdrawal

High liquidity; no exit loads in most cases


Choosing between these funds depends on your investment horizon, liquidity requirements, and risk appetite.

Conclusion

Ultra short duration mutual funds offer a balanced investment option for those seeking a combination of safety, liquidity, and potential returns. With a focus on short-term debt instruments, these funds cater to conservative investors with a specific time horizon. The advantages, including lower interest rate risk, potential for better returns than traditional savings instruments, and flexibility, make them suitable for various financial objectives. However, it is crucial for investors to consider factors like credit quality, expense ratio, and their own risk tolerance before making investment decisions. While not entirely risk-free, ultra short term funds provide a valuable tool for diversifying portfolios and addressing short-term financial goals. As with any investment, thorough research and understanding individual financial needs are essential for making informed choices in the dynamic landscape of mutual fund investments.

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Frequently Asked Questions

How long should I stay invested in Ultra Short Duration Mutual Funds?

Investors can choose their investment horizon based on financial goals. However, these funds are ideal for short to medium-term investment periods.

Where do Ultra Short Duration Mutual Funds invest?

These funds primarily invest in debt money market instruments with an investment horizon of a few weeks to a few months.

Are Ultra Short Duration Mutual Funds high risk?

While not high-risk, they are not risk-free. Investors should be aware of interest rate and credit risk associated with the fund's portfolio.

What kind of returns can I earn from Ultra Short Duration?

Returns vary, but historically, these funds have provided better returns than traditional savings instruments.

Will ultra-short funds give me assured returns?

No mutual fund can assure returns. Ultra Short Term Funds aim for stability, but returns are subject to market conditions.

Is ultra short term fund safer than FD?

Fixed deposits from reputed institutions provide fixed returns and capital safety, ideal for risk-averse investors. In contrast, ultra short duration funds offer slightly higher return potential during favourable market conditions but come with some risk. They are highly liquid, making them suitable for short-term investment needs with flexible access.

What is the difference between money market and ultra short term funds?

Both aim for low risk and stable returns, but ultra short-term funds have slightly higher potential returns. They achieve this by investing in securities with maturities ranging from 3 months to 1 year, compared to money market funds which stick to even shorter maturities (typically below 3 months). This slight difference in maturity allows ultra short-term funds to tap into a wider pool of investments, potentially offering better returns.

What are the risks of ultra short term funds?

While still low risk, ultra short-term funds have two main risks: interest rate risk and credit risk. If interest rates rise, the value of the fund can dip. Credit risk comes from investing in lower-rated debt, which carries a small chance of default.

When to invest in an ultra short duration fund?

Consider ultra short-term funds for parking your emergency fund or short-term savings goals. They offer easy access to your cash while potentially providing slightly better returns than traditional savings accounts. They're also suitable for investors seeking low-risk investments to balance out a portfolio with higher risk assets.

Which is better, liquid funds or ultra short term funds?

The choice depends on your needs. Liquid funds are ideal for immediate liquidity and very low risk, while ultra short term funds offer higher returns for slightly longer durations but with marginally more risk. Choose liquid funds for emergencies and ultra short term funds for parking money for 3-6 months.

What is the maturity of ultra short term funds?

Ultra short term funds invest in securities with an average maturity of 3-6 months. This short maturity period ensures reduced interest rate risk and stable returns, making them suitable for investors looking to park their funds for a brief yet slightly longer duration than liquid funds.

Is there any exit load in ultra short term funds?

Some ultra short term funds may impose an exit load if withdrawals are made within a specified period, usually a few days to weeks. This is to discourage premature redemptions and ensure efficient portfolio management. Check the fund's terms for specific exit load details before investing.

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The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. 

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