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Know your debt funds: Ultra short-term funds

LiveMint logoLiveMint 22-05-2017 Kayezad E. Adajania

If a liquid fund is a savings deposit substitute, then an ultra short-term debt fund can be used to keep the money for needs that are slightly more long term. This is the second debt fund decoder in this series, where we discuss seven broad categories of debt funds. You can read all the stories at:

Ultra short-term bond funds are close cousins of liquid funds but some can be vastly different. Unlike Securities and Exchange Board of India’s (Sebi) rules for liquid funds, that they can only invest in securities that mature up to 91 days, ultra short-term bond funds have no such rule. They can invest in securities that mature before or beyond 91 days. Typically, these funds invest in securities that mature within a week to about 18 months. If you wish to park your cash for 1-9 months, then this one is for you.

Paras Jain/Mint

The main risk with these funds is that one fund can be quite different from another. In the absence of any regulatory definition, one fund could be like a liquid fund and another one could be closer to a short-term bond fund. There are three broad strategies that fund houses use for these funds.

First, some of these funds actively manage their portfolio’s maturity. For instance, in the past 5 years Sundaram Income Plus’s average maturity has oscillated between about 29 days (March 2013) and 3 years and 8 months (December 2012), as per Value Research’s data. Active management of maturity adds some risk to the scheme, in case the fund manager miscalculates the direction of interest rates in the country.

Second, some schemes like Franklin India Ultra Short Term Bond Fund-Super Institutional Plan buy low-rated scrips in the hope that when their credit rating improves, their prices—and therefore the net asset values of debt funds that have invested in them—would improve as well.

Third strategy is to tilt the portfolios towards government securities (g-secs). It’s aimed towards earning a slightly higher yield, but g-secs are volatile. For example, Edelweiss Treasury Fund—Super Institutional Plan has 54% in g-secs in its April 2017-end portfolios, as per data provided by Value Research. To avoid risk and volatility, stick to the funds that tilt towards AAA-rated instruments and avoid those that take credit risks. A credit accident can negate all your previous months’ gains. Funds with more g-secs can give a returns kicker, but can get volatile at times.

Expect returns of around 7-9% from these funds, if all goes well. These returns are moderately higher than what a liquid fund can earn you over a 1-9 month time horizon.

Financial advisers suggest that ultra short-term funds should be used for not just short-term needs but also for systematic transfer plans (STPs), instead of liquid funds.

If you wish to invest a lump sum amount in an equity fund, instead of putting everything in the equity fund in one shot, put the money in an ultra short-term fund (of the same fund house) and then give instructions to switch a regular sum every month to your equity fund.

This way, while your money lies in an ultra short-term fund, it also earns a bit more than what your liquid fund could give you.

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