Ultra short duration funds are fixed income mutual fund schemes which invest debt and money market securities such that the Macaulay Duration of the scheme portfolio is 3 months to 6 months. These funds are suitable for short term investments since they are less volatile and aim to produce more stable income compared to funds with longer duration profiles. Many investors get confused between liquid funds and ultra-short duration funds.
The main difference between liquid fund and ultra-short duration fund is the maturity or duration profile of the two schemes. Liquid funds invest in debt or money market instruments which mature in 91 days, while Macaulay Duration of ultra-short duration funds is 3 to 6 months. The yield curve is usually upward sloping. For example, as on 15th September 2020, the yield of 3 month (maturity) Government Securities (G-Sec) is 3.31%, while that of 6 month G-Secs is 3.52% and 1 year G-Secs is 3.72% (source: worldgovernmentbonds.com). Therefore, ultra-short duration funds usually seek to give higher returns compared to liquid funds. However, since the durations of these funds are longer than liquid funds, they can be slightly more volatile than liquid funds on a daily or weekly basis. Therefore, you need to have longer investment tenures for ultra-short duration funds.
These funds are suitable for conservative investors who can remain invested for at least 3 months - up to 1 year. Please note that ultra-short duration funds do not guarantee capital safety or assure returns. You need to have appetite for daily or weekly volatility. However, if your investment horizon is longer than 3 months, then probability of making a loss is lower. Further, please note that, if your investment horizon is 1 year or longer then there may be more suitable investment options.
Many investors, who have surplus funds which they may not need in the next 3-12 months may keep these funds parked in their savings bank account. You can put such idle money to productive use i.e. get potential returns, by investing it for 3 – 12 months in ultra-short funds. Savings bank interest rates of major PSU and private sector banks are currently in the range of 2.75 – 3.5%. Ultra-short duration funds have the ability to generate higher returns compared to your savings bank interest rate. In fact current (last 3 months) ultra-short duration fund returns on an annualized basis are nearly 90 – 150 bps higher than even 6 – 9 months FD rates of major banks (Source: Advisorkhoj Research and policybazaar.com data as on August 2020).
If your investing holding period is less than 36 months, then the capital gains arising from the sale of units of ultra-short duration funds will be added to your income and taxed according to your income tax slab rate.
You can make your surplus funds work for you to seek to generate returns, by investing them in ultra-short duration funds instead of keeping it idle in your savings bank account. You should discuss with your financial advisors, if ultra-short duration funds are suitable for your short term investing needs.
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