Ultra Short Duration Funds

These funds are subject to both credit risk as well as interest rate risk, and hence they can be a good choice for investors who understand this kind of risk level.
Conservative investors who can remain invested for a period ranging between 3 months to 1 year should go in for these investments.

According to experts, ultra short term funds can be used by investors for both short term investments as well as for systematic transfer plans (STPs). For example, suppose a person intends to invest in equity funds instead of putting all their funds in a one-time lump sum fund. In that case, they may invest it in an ultra short term fund belonging to the same fund house and later instruct your fund manager to switch a regular amount to your equity fund every month.

It should be noted that these funds do not generate assured returns or capital safety. However, if you hold funds for more than three months, then the possibility of incurring losses is much lower.

Ultra short term funds are open ended funds, and the maturity varies from fund to fund.
The maturity period of these funds is very short but longer than other liquid funds.
Investors can buy and sell the units of these funds according to their NAV (Net Asset Value) on the day of the redemption.
These are fixed income mutual fund schemes that invest in both debt and money market securities.
The returns from these funds are quite predictable as they are immune to interest rate changes considering their short term maturity duration.

Risk
Due to the short maturity of their underlying assets, ultra short-term debt funds, unlike other debt funds, are partially immune to interest rate threats. These funds are somewhat riskier than liquid funds, nevertheless. When the fund manager includes low-credit rating securities in his investing strategy with the hope of future improvement, he may add credit risk. Additionally, the addition of government securities may cause the fund’s volatility to rise above expectations.

Return
If all other conditions are met, an investor can anticipate returns from ultra short-term funds of roughly 7% to 9%. By comparing this return rate with the various fund categories, you can see that these returns are a little more than what a liquid fund, for example, can bring in over the same one to nine-month time horizon.

These funds are havens for fixed-income investors, but they don’t provide returns that are guaranteed. When interest rates in the economy increase, these funds’ NAV(NAV) often declines. They are therefore appropriate for a system of lowering interest rates.

Cost
An expense ratio is a cost associated with managing your money in very short-term funds. SEBI limits the maximum expense ratio to 1.05%. Long-term holding periods and lower expense ratios will help recoup the money lost due to changes in interest rates compared to liquid funds, given the overall returns provided by these products.

Tax on Gains
Capital gains from investing in these funds could be taxed. The holding period, the length of time you remain invested in this fund, is used to determine the tax rate.

Short-term capital gains are capital profits generated in less than three years (STCG).

Long-term capital gains are those gained over three years or longer (LTCG).

The STCG increases the investor’s income from these funds, and his income bracket determines his tax rate. Taxes on long-term capital gains (LTCG) from these funds are 20% after indexation and 10% without it.

Financial Horizon
The short-term instruments’ coupon is how ultra short-term funds make money. These securities’ prices are subject to daily fluctuations and relatively long maturities. Since they are far more erratic than liquid funds, a brief period may not seem like enough time to produce adequate returns. Due to the higher average maturity of the underlying securities, you need to keep these products for a more extended period than you would with liquid funds.

Financial Targets
These monies are available for a range of uses. These funds may be helpful if you need to set aside money for three- to one year. Furthermore, you could want to use these to move your money to a riskier choice like equity funds.

Put a big sum of money into these funds and start an STP for systematic transfers to equity funds. You might consider them a second haven you can utilize as an emergency fund. If you require regular income, put some of your superannuation funds into them and start a systematic withdrawal plan (SWP).

When investments are for less than three years maturity duration, they come under the short term capital gains category (STCG). A tax amount is charged by adding the amount of the return to your total income and then taxed as per your income tax slab rate.

On the other hand, investments with a holding period of more than three years fall under the long term capital gains (LTCG) category. They are then taxed at a rate of 20% with indexation benefit and 10% without indexation benefit.

Since gains from ultra short term funds fall under the first category of STCG, they are taxed accordingly.

Credit risk- The fund manager’s investment strategy might have low credit quality securities, expecting to upgrade them in the future. This risk of default by the issuer of the underlying securities exposes the fund to credit risk.

Interest rate risk- There is always a risk pertaining to the increase and decrease in the interest rates on the value of the fund, even though the returns on ultra short term funds are more or less predictable owing to their short maturity duration.

Liquidity risk- This risk may arise due to the fund house’s inability of not having sufficient liquid funds to meet their redemption requests.

Hence, to minimize the above risks involved with ultra short term funds, it is important to research about the portfolio fund and ensure that investments are done in high rated securities.

Further, you need to make sure that the fund manager/ fund house has relevant experience in managing investments and switching interest rate regimes amidst rising and falling markets so that your fund performs optimally.

There are several advantages of investing in ultra short fund portfolios which can be listed as under:

Good to park your short-term money- Any surplus money which you do not require for a period of 3 to 6 months can be parked in the ultra short term funds. You can opt for quarterly or six monthly payments, and thus make a little higher returns on your investments without taking too many additional risks.

Very low total expense ratio (TER)- These funds are required to provide MTM daily basis. However, being invested for less than a year, these funds have very low price risk levels. Also, even though these funds charge exit loads, the exit ratio is much lower than short term funds.