With the Securities and Exchange Board of India (SEBI) categorizing debt funds into 16 categories, investors can now choose the fund that is best suited to their investment plan. For conservative investors with an investment horizon of maximum six months, Ultra Short Mutual Funds are a good option. These funds have a longer duration than overnight funds and liquid funds but shorter duration than the other debt funds. Here, we will explore Ultra Short Term Mutual Funds and talk about everything that you need to know about them before investing.
What are Ultra Short Term Mutual Funds?
Ultra Short Term Mutual Funds invest in debt securities and money market instruments so that the Macaulay Duration of the fund's portfolio is between three and six months. Hence, conservative investors with a 3-6 month investment horizon find these funds ideal. These funds are best suited for investors who want to meet certain financial goals in 6 months. The average returns of these funds range between 7 and 9%.
How do Ultra Short Term Funds work?
The fund manager of an Ultra Short Mutual Fund selects money market instruments and debt securities according to the investment objective of the fund ensuring that the Macaulay duration is between 3 and 6 months.
Should You Invest in Ultra Short Funds?
Since the Macaulay duration of the portfolio of an Ultra Short Fund is between 3 and 6 months, it is best suited to investors with an investment horizon of around six months and a lower risk preference. Further, these funds tend to offer better returns than keeping your funds in a savings account for a similar tenure. Also, it is important to ensure that you invest according to your financial plan and investment objectives.
Factors to consider before investing in Ultra Short Term Funds in India
Here are some important aspects that you must consider before investing in Ultra Short Term Funds in India:
Risks and Returns
An Ultra Short Term Fund is a debt fund and carries the three risks that all debt funds carry:
- Credit risk - which is the risk of default by the issuer of the underlying securities
- Interest rate risk - which is the effect of an increase or decrease in interest rates on the value of the fund
- Liquidity risk - which is the fund house's risk of not having sufficient liquidity to meet redemption requests.
Therefore, it is important to study the portfolio of the fund to ensure that it invests in high-rated securities making the credit risk negligible. Further, you should research the fund manager to see how he has performed in the past when the interest rate cycles were rising and falling. Remember, a fund manager with relevant experience in managing investments through changing interest rate regimes can ensure that the fund performs optimally. A well-managed Ultra Short Fund portfolio should earn around 7-9% returns.
Expense Ratio
The returns of an Ultra Short Term Debt Fund are usually lower than an equity fund. Therefore, investors try to reduce as many costs as possible to maximize their gains. One such cost is the expense ratio which is a fee levied by the fund house towards fund management services. You must look for schemes with a lower expense ratio.
Investment Plan
A solid investment plan is the foundation of a successful investor. You need to clearly define your investment objectives, risk tolerance, and investment horizon. It is important to understand that Ultra Short Funds are designed for conservative investors with an investment horizon of up to 6 months. If you have longer or shorter financial goals, then you must look for appropriate schemes.
