Ultra Short term funds: An analysis

In today’s time and age, money is the most important factor for leading a comfortable life. You can use it to purchase a good car, eat lavish meals, watch beautiful art, and do a lot more overall.

But the latest issue with money is that its value begins degrading by itself. Because of inflation and the rising cost of living around the world, if your money is lying idle in a bank, you will have to incur a loss every year. This has essentially made banks redundant for storing money.

So what prudent people do these days is that rather than keeping their money in banks, they invest it in various places. This gives them the benefit of having a different interest rate than a bank and maybe overtake inflation to turn in a profit as well.

What are Ultra Short Funds?

Every fund in which you can invest has a maturity period. This period is essentially the time for which you need to hold money in the invested fund, after which you can take back your investment along with the earned interest. This period is called the Macaulay Duration.

Ultra Short Funds are funds that have a Macaulay duration of 3-6 months. These funds are quite similar to liquid funds.

According to SEBI, liquid funds cannot have a duration of more than 91 days. But since these are ultra-short-term bond funds, those rules do not directly apply here. Hence, these bonds can invest in securities that mature in or after a period of 91 days.

Characteristics

Ultra short-term funds have certain characteristics about them. Similar to other funds, these characteristics help us get an idea of how useful this investment is and what kind of factors can influence the rewards we can reap from it. 

Let us have a look at them.

Risk

When we compare them to the other funds available in the market, ultra short-term funds generally carry a much lower amount of risk with them. These funds are almost immune to interest rate risks because of the short time needed for them to mature.

The only risk that can be induced is by the investment strategy of the fund manager. He might invest hoping for an upgrade in the future, but that may lead to some credit-related risks.

While these funds are riskier than liquid funds, some of the risks may also be due to the inclusion of government bonds which increase the volatility of the fund.

Return

In the past, ultra short-term funds have generally given a return of about 7- 9%. This rate is higher than those of liquid funds, in a typical period of one to nine months. In fact, this return is higher than most other funds in the same category. 

But even though these funds usually invest in fixed-income assets, the return from them is not always guaranteed. 

Also worth noting that these funds have an inverse relation with the interest rates of the market. Whenever the interest rates fall, the NAV (Net Asset Value) of these investments rises.

Cost

Just like all the other funds in the market, there are some costs associated with investing in these funds. This fee of managing these assets is called the expense ratio. To keep the expense ratio in check, SEBI has established the upper limit of the expense ratio to be 1.05% of the entire investment. 

To maximize your profits, you should look for a fund that has a long holding period and low expense ratio.

Investment Horizon

The prices of these funds have the potential to change on a day-to-day basis and they also have a relatively longer maturity than liquid funds. A short time period may not be enough to generate sufficient returns as they have more volatility than liquid funds. 

Hence, a time period of 1 week to 18 weeks makes up the investment horizon of these funds.

Monetary Goals

Ultra short-term funds can be used for a plethora of reasons and purposes. These funds are essentially a safe haven for you to store your money for up to 3 months a year. These funds can also act as a backup emergency fund.

If you want to invest in another place where you cannot do so directly, such as large amounts of equity funds, you can invest in these and conduct a systematic transfer plan (STP). 

These funds can also act as a monthly source of income, by opting for a systematic withdrawal plan (SWP), after investing a good sum of money in them.

Taxation

The taxation of the funds is done on the basis of the time for which these were held.

If the funds are held for a period of fewer than three years, then they are called short-term capital gains (STCG). In the case of STCG tax, the gains are added to the investor’s income and taxed according to the income tax slab rate.

If the funds are held for more than three years, then they are called long-term capital gains (LTCG). Under the LTCG tax, the returns are taxable at 10% without indexation, and 20% with indexation. 

It is worth noting that by holding for a period of more than three years, the taxpayers of the highest tax bracket can save tax as it will only be taxed at 20% with indexation.

Advantages

  • They can generate better returns than short-term bonds and money market accounts.
  • There is little to no risk for someone who invests for more than 3 months.
  • The best method for keeping money aside for a few weeks or months.
  • No dangers of interest rate risks. Interest rate changes do not have as much impact on them as long-term funds.

Disadvantages

  • The expense ratios can be a bit on the higher end when compared to other funds. This is because the upper limit of expense ratios is 1.05%.
  • There are still risks related to credit and default which depend on the strategy of the manager.
  • A fixed-income fund has comparatively more regulation and monitoring than ultra short-term funds.

Who should invest in them?

Ultra short-term funds are the most beneficial to those investors who are looking for a place to store their cash for a short period of around 3 months. 

They are also very useful to people who plan for systematic transfer plans (STPs) to invest in other places such as equity funds, while also taking the benefits of these short-term funds.

Investors who want low risks or looking for ways to decrease their taxes can also invest here.

Conclusion

When we do not know what to do with the money in our hands, we either end up wasting it or keep it idle in a bank where it slowly deteriorates. 

Ultra short-term funds give us a wise and helpful option to store our money where it can increase gradually while providing us with the numerous benefits discussed above. 

It is now clearly evident that smart investors can use ultra short-term funds to their advantage and make the best use of their money to live a life full of luxury and comfort.

Related posts

GraphUP-icon-250x250-1
GraphUp
Logo-1
CapitPlan
TradeCross
TradeCross
priMarket-icon-250x250-1
PriMarket
DECK-icon-250x250-1
Deck