What are Ultra Short Term Mutual Funds?
- 2 January 2020 | 581 Views | By Abhinav Mishra
In today’s time, people face financial insecurities every now and then. The employment and business opportunities that exist are constantly changing and may result in instabilities in one’s income. In such a scenario, sensible investment in Mutual Funds can open up other sources of income, which would moderate dependency which may be purely be based on salary or business profits and help an investor manage the financial uncertainty in their lives. With the Securities and Exchange Board of India (SEBI) classifying debt funds into 16 categories, investors can now choose from the variety of funds and choose the one that is best suited to their investment plan. For example, for conservative investors with an investment horizon of maximum of six months, Ultra Short Mutual Funds are a good option.
Ultra Short Term funds are one such investment that offers a good return to the investors in order to manage their financial insecurities. These funds have a longer duration than overnight funds and liquid funds but shorter duration than the other debt funds investible across the markets. Here, we will explore Ultra Short Term Mutual Funds and talk about everything that you need to know about them before investing, as mutual fund investors are generally confused about whether to park their short-term money and often confused as to whether to park their money in liquid funds or ultra short duration funds.
What is Ultra short term Mutual Funds?
Ultra Short Term Funds are short-term investments that are highly suitable for investors who are willing to marginally increase the risk of investment to earn good returns in a very short span of time. Ultra short-term mutual funds are fixed-income earning instruments of maturities up to six months.
Ultra Short Term Mutual Funds invest in debt securities and money market instruments so that the period 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 expected out of these funds may range between 7 and 9%.
Factors to consider while investing in Ultra Short term Mutual Funds
While selecting such a mutual fund, one needs to scrutinize the fund from different perspectives. There are various quantitative and qualitative parameters that can be used to arrive at the best ultra-short term mutual funds as per the investor’s requirements. Additionally, the investor needs to set their financial goals, risk appetite and investment horizon in mind before selecting any fund. Some of the factors to ponder upon before investing in Ultra short-term mutual funds include:
- Risk appetite: Unlike other funds, the ultra-short term 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 lead to credit risk when he or she incorporates low-credit rated securities in the expectation of an upgrade in the future. Moreover, the introduction of government securities may increase the volatility of the fund more than expected. 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.
- Return: The returns on ultra short-term funds are relatively higher. An investor may achieve returns of around 7%-9% from ultra short-term funds, subject to the fact that every other factor falls into place. This return is relatively higher than what a liquid fund offers. But on a cautious note even though these funds are fixed-income havens, they may not offer guaranteed returns.
- Cost: Ultra short-term funds charges a fee to manage the investor’s money termed as the expense ratio. Till now, SEBI had directed 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 would help in recovering the money gone out by way of interest rate fluctuations.
- Tax on gains: Investing in Ultra-short duration funds attract to the investors taxable capital gains on its redemption. The respective taxation rate is directly associated with the holding period of the investment.
- When the holding period is less than or equal to 3-years, the capital gains are called Short Term Capital Gains (STCG). These gains are added to the income of investors and stand taxable according to the income slab of every investor.
- When the holding period is more than or equal to 3-years, the capital gains are called Long Term Capital Gains (LTCG). These capital gains have a taxation rate of 20% after indexation benefits and 10% before indexation.
- Dividends: Dividends received of Ultra Short Term Funds in India are tax-free in the hands of the investor. This is so because the AMC deducts a Dividend Distribution Tax (DDT) on behalf of the investor before it sends the dividend to the investor, thus tax-free in the hands of the investor.
Amongst all the variety of Ultra short-term funds available, best ones are those very short term Mutual Funds that invest in a combination of debt instruments including treasury bills, certificate of deposits, commercial papers and corporate bonds. Generally, these funds have a residual maturity ranging from 6 months to 1 year.
The market risk present usually restricts the investors from indulging in Mutual fund investments. As a result, they tend to prefer saving accounts over Mutual funds. However, Ultra Short Duration funds that are liquid as well as less volatile can be considered as one of the best investment plans.
A solid investment plan is the foundation of a successful investor. One needs to clearly define their investment objectives, risk tolerance, and investment horizon. It is important to understand that Ultra Short Funds are designed for conservative investors and thus investment should be made with an investment horizon of up to 6 months. If the investor has longer or shorter financial goals, then you must look for other appropriate schemes.