Can I use ultra short duration funds instead for short-term goals?

Published: August 11, 2022 at 6:00 am

A reader asks, “You usually recommend money market funds for short-term goals. Can we also consider Ultra Short Duration Funds for this purpose?’

The definition of money market funds is simple: “Investment in Money Market instruments having maturity up to 1 year”.Ultra-short duration funds are defined as “investment in Debt & Money Market instruments such that the Macaulay duration of the portfolio is between 3 months -6 months.

From “ultra short term funds”, they became “ultra-short duration funds” after the SEBI categorization rules came into force. The two phrases need not be the same! This gives Ultra short-duration funds a bit more room to be flexible than money market funds.

To understand more about the Macaulay duration, refer to:

Considering the average portfolio maturity or the modified duration (a measure of interest rate sensitivity, see above link for explanation), it will be hard to distinguish the two categories. We need to dig deeper. We shall refer to the July 2022 Debt Mutual Fund Screener for this.


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Money Market Funds

  • Average maturity range  of category: 0.28 years to 0.64 years
  • Modified duration range of category: 0.27 years to 0.45 years

Ultra short duration funds

  • Average maturity range  of category: 0.26 years to 0.54 years
  • Modified duration range of category: 0.26 years to 0.45 years

So there is nothing to separate the two categories based on these two metrics.

Because of the way in which they are defined, money market funds only hold bonds up to 12 months in duration or cash or derivatives corresponding to the bonds. Ultra short-duration funds are more flexible. Here are some examples:

  • Aditya Birla SL Savings Fund holds 13.45% of bonds maturing between 1-3 years.
  • Axis Ultra Short Term Fund holds 6.16% of bonds maturing between 1-3 years;   0.29% of bonds maturing between 3 to 5 years, and  0.28% of bonds maturing above 5 years.

This freedom stems from the category definition. Money market funds are defined in terms of tenure, while ultra-short duration funds are defined in terms of “duration” A bond fund manager can hold significant amounts of long term debt (> 1 year) and yet keep the Macaulay duration of the portfolio between 3 months -6 months.

This means ultra-short duration funds can be more volatile than money market funds with sharper up or downturns. It is hard to find style purity in terms of bond duration in this category. A new investor is better off with the money market category.

The second issue concerns the credit rating profile. All money market funds hold either cash or A1-rated bonds. This is the highest short-term rating corresponding to AAA of long-term bonds. The rating can vary from A1+ to A1 to A1- although A1+ is the most common.

Ultra short duration funds are more adventurous. The following funds hold 10% to 20% of AA/AA+/AA- rated bonds as of July 2022.

  • Kotak Savings Fund(G)
  • Invesco India Ultra Short Term Fund(G)
  • Aditya Birla SL Savings Fund-Reg(G)
  • Axis Ultra Short Term Fund-Reg(G)
  • UTI Ultra Short Term Fund-Reg(G)
  • ICICI Pru Ultra Short Term Fund Fund(G) – also holds 1% of A / A+ / A- bonds.
  • Nippon India Ultra Short Duration Fund(G)

So the chance of credit rating change or even default is higher in the ultra-short duration category.

Today it is easy to find an ultra-short duration fund that does not invest in low-rated bonds. However, it may not remain so in future.

Unlike money market funds, ultra-short duration funds lack style purity in duration and credit rating across the category. So we recommend new investors stay away from the ultra-short category. The possibility of a higher return is not worth the additional risk. A money market fund is a simpler, cleaner choice.

That said, adventurous investors can consider ultra-short duration funds However, we recommend using them for more than three-year goals. Do keep an eye on the credit rating profile of the portfolio from the fund fact sheets. Do not get misled by the “average credit rating” shown in fund rating portals.

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