FundsIndia Explains: What are ultra short term funds?

You know that liquid funds are useful to create emergency funds or for systematic transfers into equity funds or to temporarily park money you may need at any time. Another category of debt funds, called ultra short term funds (sometimes called liquid-plus funds) are often interchanged with liquid funds. However, there is quite a difference between the two categories.

Ultra short term funds (UST funds) are very short-term debt funds that seek to invest in a combination of certificates of deposits, treasury bills, commercial papers, and corporate bonds with average maturities ranging from 6 months to 1 year in most cases. Liquid funds also invest in very short-term instruments, but there are some key differences. Here they are:

UST funds have a longer average maturity: Liquid funds hold a liquid portfolio of debt instruments, typically until maturity. The average maturity of the instruments does not exceed 91 days. The change in the daily NAV primarily stems from the daily interest accruing on the various instruments. There would be no mark-to-market or volatility in price, except in very exceptional circumstances.

UST funds also earn from interest accrual on instruments held. These instruments, however, have a longer maturity. UST funds may also hold instruments that are marked to market – i.e., bond prices may change on a day-to-day basis. They are more volatile than liquid funds, especially in the short term of 1-3 months. For instance, nearly half the universe of UST funds has shown a period of negative returns even over a one-month timeframe – a clear indication that they are not meant for the very short term. The longer average maturity for UST funds means that you need to hold them for longer periods than you would a liquid fund.

UST funds invest in a wide range of instruments and have a different risk profile. Liquid funds mostly hold treasury bills and some certificates of deposits. UST funds hold a combination of various short-term instruments, which can include AAA and even AA-rated bonds and this opens up a wide range of investible instruments. The risk profile (and therefore their return potential) of UST funds is slightly higher than that of pure liquid funds.

Within UST funds, there can also be more variance in returns because of the size of the investable universe. For example, funds such as Franklin India Ultra Short Fund have a high proportion of investments in AA-rated bonds and with an average maturity exceeding 300 days. Those such as Axis Treasury Advantage have half the average maturity and hold more commercial papers and AAA-rated instruments. As a result, the return differential between the funds will also be high. With liquid funds, the universe is more or less the same. You will not have much variance in the performance of funds within the category.

UST funds can have exit loads: Liquid funds do not have any exit load as they are meant to be ‘anytime money’. However, some UST funds do carry an exit load if you redeem them within a short period. This period varies from fund to fund.

When you can invest

UST funds are, therefore, not a substitute for your savings bank account. That’s the domain of the liquid fund. Where UST funds are suitable are:

• Park money that you need in the next 3 months to a year
• Substitute for very short-term bank deposits of 90 or 120 days
• Park money that you will need for paying your insurance premium or school fee if such need is at least a good 6 months away
• To build your emergency corpus, along with liquid funds
• To generate monthly income through a systematic withdrawal plan, by parking a portion of your retirement portfolio in UST funds (along with other categories of debt funds such as short-term and income funds)
• To build a comprehensive debt portfolio with the right mix of liquidity and return by using it along with higher-yielding options such as short-term, dynamic bond, or income funds

 A word of caution here – due to the varying nature of instruments held, ultra short-term funds that invest in low credit quality papers can be very risky. Therefore, make sure to check the rating profile of the fund before you invest in them. Remember that higher returns come from taking higher risk.