Will ultra short term funds help you meet upcoming goals without hassles?

Posted by amrina alshaikh on June 1st, 2021

There has been rising popularity of ultra short term funds in India over recent months. Industry experts attribute the same towards enhanced awareness regarding short term mutual funds in India and the efficacy of these types of debt mutual funds in India with regard to ironing out risks and generating steady returns. Ultra-short term funds may be quite similar in functioning to liquid funds. They ensure higher liquidity as compared to other classes of funds which have longer investment durations. As per the regulations of the SEBI (Securities and Exchange Board of India) in case of liquid funds, it has been seen that these funds may only invest in securities which mature within 91 days.

Yet, these regulations are not applicable for ultra short term bond funds and other similar debt schemes. These bonds may hence invest in securities which mature both prior to and post 91 days. Usually, the horizon for investment for such funds will vary from one week to roughly 18 months on average. If you possess surplus funds to be parked for a tenure of 1-9 months and from which you seek handsome dividends, then this option may be suitable indeed. There are several investors who prefer investing in debt equity funds and other types of balanced funds as well. Yet, ultra short term funds should be deployed for meeting requirements in the short term and also for STPs (systematic transfer plans) as substitutes for liquid funds.

Suppose you are desirous of investing a lump sum in any regular equity funds. In place of putting the money in the fund as a lump sum, you may invest in the ultra short term fund. You can also have instructions given for switching a regular amount each month to the equity fund from the same. In this manner, you do not keep your money idle and it will have greater liquidity in the ultra short term fund while also earning slightly more dividends than conventional liquid funds. Ultra short term debt funds are majorly immune towards risks arising from interest rates on account of shorter maturity of underlying assts. Yet, in comparison to liquid funds, these funds have higher risk levels.

The investment blueprint may encompass credit risks courtesy of the fund manager when he/she integrates securities with lower credit ratings in hopes of a future upgrade. Also, the integration of Government securities may enhance overall fund volatility as compared to overall expectations. Investors may expect 7-9% in returns from ultra short term schemes if things remain steady and in place. If these returns are compared with various categories of funds, then they will turn out to be higher than regular liquid funds. While these funds are ideal as fixed income instruments, the returns are never guaranteed. The NAV (net asset value) of the funds will naturally fall with an overall increase in rates of interest throughout the economy. They are thus suitable for a falling interest rate cycle.

These funds will have a fee chargeable for management of money and this is known as the expense ratio. SEBI has made the upper limit of expense ratio 1.05% and considering overall returns from these funds in comparison to liquid funds, the lower expense ratio and long-term holding tenure will enable faster recovery of money lost owing to fluctuations in rates of interest. Ultra short term funds will generate earnings from short term instrument coupons. Prices of securities may be subject to change on a regular basis while possessing comparatively longer maturity periods. These are more volatile in comparison to liquid funds along with a shorter time frame which may seem insufficient for generating ample returns. In comparison to liquid funds, you will have to hold onto these funds for comparatively lengthier durations on account of greater average maturity of underlying securities.

These funds may be used for diverse reasons. If you have to park your money for a duration between 3 months and 1 year, then these funds may be really useful. You may also wish to transfer funds to options which are slightly riskier. These include equity funds and the like. Invest a lump sum amount into these funds if you have to and then initiate your STP (systematic transfer plan) for equity funds. You may consider them to be an extra haven for usage in the manner of an emergency fund. If you require monthly income, invest a chunk of superannuation portfolios into the same and initiate the SWP (systematic withdrawal plan) likewise. You may earn taxable capital gains while investing in these funds. The taxation rate will be worked out on the basis of the duration for which you remain invested in the fund. This is also known as the holding period. Capital gains within three years will be known as short term capital gains or STCG. Capital gains earned in 3 years or more will be called LTCG or long term capital gains. STCG from the funds will be added to the income of the investor and taxed as per the income slab in question. LTCG will be taxed at 20% post indexation and 10% minus indexation benefits.