Ultra Short Term Mutual Funds: Basics, Important Factors & Benefits

Ultra short term mutual funds are open-ended debt schemes. These mutual funds invest in instruments with a Macaulay duration between three months and six months. These funds primarily invest in debt and money market instruments. These funds work well as short-term investments due to their low volatility and relatively stable income.

How Do Ultra Short Term Mutual Funds Work?

If you are searching for a solution to your short-term investment needs, then ultra short duration funds could be the answer. This is because short-term fixed income instruments such as treasury bills, commercial papers and certificates of deposit occupy a significant portion of its portfolio. These securities carry low volatility and can produce stable returns. 

Moreover, these mutual fund schemes offer sufficient liquidity. Additionally, these schemes have the potential to generate consistent and reasonable returns compared to traditional fixed-income products. 

Benefits of Investing in Ultra Short Duration Funds 

Discussed below are the benefits of ultra short duration funds:

• If people have surplus money lying in a savings account, which they will not need for the next 3-6 months, they can choose to invest in ultra short term mutual funds. These funds generate higher returns compared to savings bank accounts of PSU and public sector banks. 
• Because of the short maturity of the underlying assets, ultra short term funds have lower interest rate risks than other debt funds. 
• These funds invest primarily in highly rated corporate securities, which keep their risks low and returns higher than that of liquid funds.

Who Should Invest in Ultra Short Term Debt Mutual Funds? 

Given below are details of suitable investors: 

• People, who have no problem investing for three to six months, can invest in ultra short duration funds. 
• Investors who are conservative and prefer getting predictable returns can invest in these funds.
• People who wish to invest in ultra short term mutual funds should be comfortable with the fact that these schemes do not guarantee returns or ensure capital safety. 

List of Top Ultra Short Duration Funds in 2022

The table below lists the best-performing ultra short term funds based on their five-year annualised returns:

Taxation of Ultra Short Duration Debt Funds 

Ultra short term mutual funds are taxed just like any other debt mutual funds. Given below are details of taxation of these debt schemes: 

• The capital gains investors earn by investing in short term schemes are taxable. Additionally, the tax rate depends on the holding period of these investments. 
• If an investor earns capital gains within three years, it is referred to as short term capital gains (STCGs). These gains get added to an investor’s total income and are taxed as per their income tax slab rate. 
• However, if the holding period is three years or more, the gains are classified as long term capital gains (LTCGs). The applicable tax rate for LTCG is 20% after the benefit of indexation.

Differences between Liquid Funds and Ultra Short Duration Funds 

Liquid funds are open-ended liquid schemes that invest in debt and money market securities with a maturity period of 91 days. Ultra short duration funds and liquid funds are similar, but there are differences as well. 

The table below illustrates the differences between ultra short term funds and liquid funds:

Important Factors to Consider While Investing 

Detailed below are essential factors that you should consider once you choose to invest in ultra short term mutual funds:   

• The expense ratio of the fund

You should check the expense ratio of an ultra short duration fund. Do not forget that a high expense ratio would decrease the scheme’s returns. As it is, these funds generate low returns compared to mutual fund schemes of longer duration. So, you should choose funds that have a lower expense ratio. 

• Credit quality 

You need to check whether or not the mutual fund scheme invests in high-credit quality instruments. For this purpose, you can evaluate the scheme’s monthly factsheets. These funds can carry some credit risks despite having low-interest rate risks. 

However, credit risks can lead to a permanent reduction in the value of your investment. So, ensure that the ultra short term fund you choose has allocated its assets to AAA/ A1 rated instruments.  

• Expected returns

Many factors like RBI’s monetary policy, exchange rate and macroeconomic conditions influence the returns of an ultra short duration fund. So, do not base your decision on the short term performance of a fund. 

It may be possible that a fund resorts to taking credit risks to be able to get better yields. If you have a low-risk tolerance, you may want to avoid such schemes.

• Fund manager’s expertise

It is crucial to assess the past performances of a fund manager. This is because it is the fund manager who decides the asset allocation. So, their performance across different markets and interest rate cycles will enable you to make an informed decision. 

Additionally, evaluate the performances of all the mutual fund schemes offered by the AMC (Asset Management Company). 

• Investment horizon 

Align your financial goals with the investment horizon. The ideal investment tenure of an ultra short duration fund should be three to six months. If you prefer tenure shorter than three months, choose liquid funds. Additionally, if you wish to invest for tenure longer than twelve months, there are other suitable debt schemes. 

Final Word

The above sections have discussed all the important details about ultra short term mutual funds. These are open-ended debt schemes of shorter duration. Investors must consider expense ratio, credit quality, past performances of fund managers and their financial goals before investing in these debt mutual funds. 

Frequently Asked Questions about Ultra Short Term Mutual Funds

Q1. Is there an exit load in short-duration funds? 

Ans: Some short-duration funds may levy an exit load. AMCs deduct exit load if an investor withdraws his investment before maturity. However, the exit load is different for all mutual fund companies.

Q2. Is there a lock-in period for short-duration mutual funds? 

Ans: No, ultra short term mutual funds are open-ended schemes which do not have lock-in periods. Once an investor submits his redemption request, he will receive his money within two business days. 

Q3. Can I remain invested in an ultra short duration fund after six months? 

Ans: Yes, because it is not mandatory to withdraw your money within six months. Ultra short duration funds are open-ended debt schemes which will continue providing returns. However, the investment horizon of three to six months highlights that there are alternative investment options if you wish to invest for a shorter or longer duration than the specified tenure. 

Q4. What is the meaning of Macaulay duration of an ultra short term fund?

Ans. Macaulay duration of a bond refers to the weighted average time needed to receive cashflows equivalent to the total market price of the bond. In other words, it is the time that an investor needs to wait to receive returns equal to the bond’s principal and interest repayment.

For an ultra short term mutual fund, the Macaulay duration is the weighted Macaulay duration of all individual securities held by the fund.