Ultra Short-Term Mutual Funds – Basics, Benefits & More

Ultra short-term mutual funds are those funds that invest in fixed-income earning instruments of maturities up to six months.

How do Ultra Short-term Mutual Funds work?

Ultra-short-term funds can be likened to be close cousins of liquid funds. These funds offer more liquidity than any other class of funds with long investment horizons.

According to the rules set by the Securities and Exchange Board of India (SEBI) for liquid funds, it has been decided that such funds can invest only in securities that mature no longer than 91 days. However, these rules do not apply to ultra short-term bond funds. These bonds can, therefore, invest in securities that mature both before or after 91 days.

Typically, the investment horizon for these ultra-short-term funds ranges from a week to about 18 months. Hence, if you have surplus funds that you wish to park for 1 month to 9 months and earn some dividends from, then this investment vehicle can be the one you are looking for.

Who should invest in Ultra Short-term Mutual Funds?

Experts suggest that ultra short-term funds should be used by investors for both short-term investment needs as well as for systematic transfer plans (STPs), in place of liquid funds.

Say you wish to invest a lump sum amount in an equity fund. Now, instead of putting all your cash in the equity fund in a one-time lump sum, it is advisable that you invest in an ultra short-term fund (belonging to the same fund house). You can then give instructions to switch a regular sum every month to your equity fund.

This way, you get two benefits: your money will lie in an ultra short-term fund which offers high liquidity, and will also earn slightly higher dividends than a regular liquid fund.

Things to Consider as an Investor

Risk

Unlike other debt funds, the ultra short-term debt funds are somewhat immune to interest rate risks because of the short maturity of their underlying assets. However, as compared to liquid funds, these funds are pretty risky. The investment strategy of the fund manager may introduce credit risk when he incorporates low-credit rated securities in the expectation of an upgrade in future. Moreover, the introduction of government securities may increase the volatility of the fund more than expected.

Return

An investor can expect returns of around 7% to 9% from ultra short-term funds; given that every other factor falls into place. If you compare this return rate with the different fund categories, then you will see that these returns are somewhat higher than what a liquid fund, for instance, can earn you over the same one to nine-month time horizon. Even though these funds are fixed-income havens, they don’t offer guaranteed returns. The Net Asset Value (NAV) of these fund tends to fall with a rise in the overall interest rates in the economy. Hence, they are suitable for a falling interest rate regime.

Cost

Ultra short-term funds charge a fee to manage your money called an expense ratio. SEBI has mandated the upper limit of expense ratio to be 1.05%. Considering the overall returns generated by these funds as compared to liquid funds, a long-term holding period and lower expense ratio will help to recover the money gone out by way of interest rate fluctuations.

Investment Horizon

Ultra short-term funds earn from the coupon of short-term instruments. The prices of these securities may change on a day-to-day basis and have a relatively longer maturity. These are much more volatile than liquid funds, and a short time frame may seem inadequate to generate sufficient returns. As compared to liquid funds, you need to hold these funds for comparatively longer horizon owing to a higher average maturity of the underlying securities.

Financial Goals

You may use these funds for a variety of purposes. If you need to park money for a period of three months to a year, then these funds may come handy. Additionally, you may want these to transfer your funds to a riskier option such as equity funds. Invest a lump sum in these funds and initiate a systematic transfer plan (STP) to equity funds. You may look at them as an additional haven to be used as an emergency fund. If you need monthly income, then invest a portion of your superannuation portfolio in these and initiate a systematic withdrawal plan (SWP).

Tax on Gains

When you invest in these funds, you may earn taxable capital gains. The rate of taxation is calculated based on how long you stay invested in this fund called the holding period.

• Capital gains made within three years is known as a Short-term Capital Gain (STCG).
• Capital gains earned over three years or more is known as Long-term Capital Gains (LTCG).

STCG from these funds are also added to the investor’s income and taxed according to his income slab. LTCG from these funds is taxed at the rate of 20% after indexation and 10% without the benefit of indexation.

Advantages of Ultra Short Term Mutual Funds

• Ideal when you need to keep money invested for few weeks or months, but with liquidity
• Negligible risk of loss if you extend holding period over 3 months
• Higher returns than fixed deposits with banks

How to Invest in Ultra Short-Term Mutual Funds

Investing in ultra-short-term mutual funds is made paperless and hassle-free at ClearTax.

Using the following steps, you can start your investment journey:

Step 1: Sign in at cleartax.in

Step 2: Enter all the requested details

Step 3: Get your e-KYC done, it can be completed in just 5 minutes

Step 4: Invest in the most suitable fund from amongst the hand-picked mutual funds

Top 5 Ultra Short-Term Mutual Funds in India

While selecting a fund, you need to analyse the fund from various perspectives. There are various quantitative and qualitative parameters, which can be used to arrive at the best ultra short-term mutual funds as per your requirements. Additionally, you need to keep your financial goals, risk appetite and investment horizon in mind.

The following table shows the top 5 ultra short-term mutual funds in India based on the past three year returns. Investors may choose the funds based on a different investment horizon like five years or ten years returns. You may include other criteria such as financial ratios as well.  

Selecting the right ultra short-term mutual fund might be a difficult task. In case tracking financial markets isn’t your thing and you are finding it too difficult to understand, then go for ClearTax Invest. You can invest in hand-picked funds by investment experts in a hassle-free and paperless manner.

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