Best Ultra Short Term Fund

Ultra short term funds are open ended debt funds. According to SEBI, the fund’s portfolio should have securities with a maturity of 3 to 6 months. These funds have sufficient liquidity and best suit investors with surplus cash available for the next 3-6 months. Gains from ultra short duration funds are taxable just like debt funds. In this article, we have covered what are ultra short term funds, how do they work and the top performing ultra short duration funds.

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Top 5 Performing Ultra Short Term Funds 2024

Fund Name	3 Year Returns	5 Year Returns
Aditya Birla Sun Life Savings Fund (G)	6.4%	6.1%
SBI Magnum Ultra Short Duration Fund (G)	6.1%	5.6%
Bandhan Ultra Short Term Fund (G)	6.1%	5.5%
HDFC Ultra S T Fund (G)	6.1%	5.7%
ICICI Prudential Ultra Short Term Fund (G)	6.1%	5.9%

What are Ultra Short Term Funds?

Ultra short term funds or Ultra short duration funds are open ended debt mutual funds. These funds have a Macaulay duration between 3 to 6 months. In other words, these funds have securities with maturity between 3-6 months period. These funds primarily invest in money market instruments or fixed income securities like treasury bills, commercial papers and certificates of deposit with maturities below six months.

Ultra short term funds provide reasonable returns with sufficient liquidity. The low maturities make the fund less sensitive to interest rate movements in the market. The fund has the potential to offer higher growth than other long maturity debt funds during a rising interest rate regime.

These funds believe in generating return by holding the securities until their maturity. These funds best suit investors who have surplus funds for a period of 3-6 months.

Gains on ultra short term funds are taxable. They are taxed similar to debt mutual funds. The short term capital gains are gains arising from investments redeemed before three years from the investment date. On the other hand, long term capital gains are those gains arising from investments redeemed after three years from the investment date. Short term capital gains are taxable at the individual’s income tax slab rate. While long term capital gains are taxable at 20% with indexation benefit and 10% without indexation benefit. By holding investments for more than three years, investors of the highest tax slab can save tax. This is because the taxation for long term gains is 20% with indexation benefit.

As per the new Finance Bill 2023, capital gains from debt mutual funds from April 1st 2023, will be taxed as per the investor’s income tax slab rate.

How Do Ultra Short Term Funds Work?

Ultra short term funds are similar to liquid funds but with a longer maturity than liquid funds. They are more liquid than other debt funds with long durations. According to SEBI regulations, ultra short duration funds should invest in securities with a maturity of 3-6 months.

Returns from ultra short term funds are predictable as they come with low maturities. The return is calculated based on rise or fall in the Net Asset Value (NAV). The NAV of the fund rises or falls with a change in interest rates.

Though the fund is less sensitive to interest rate movements than a debt fund with longer duration, there is still an element of interest rate risk present. Hence this fund is best suitable during falling interest rate regimes. The fund is also prone to credit risk. If the fund manager’s choice of investments is more inclined towards low rated securities (low credit quality), the chance of default risk is high.

Things to Remember Before Investing

Investment and Financial goals

Ultra short term funds are debt funds that offer liquidity more than any other long term investment funds. The advisable investment duration in these funds ranges between one week to 18 months. Therefore, investors looking at short term investments can consider investing in ultra short term funds. Investors with short term financial goals such as payments which are a month away. Instead of holding the cash in a savings bank account, they can invest in ultra short term funds. Or have an emergency fund. Hence, based on the cash requirement, investors can invest in ultra short term funds. Additionally, investors can also use these funds for Systematic Transfer Plans (STPs) and Systematic Withdrawal Plans (SWPs).  

Investment horizon

Typically, the investment horizon for these funds ranges between one week to 18 months. These funds invest in securities with longer maturity. Therefore, one can invest in these funds for slightly longer durations in comparison to liquid funds owing to the higher average maturity of the securities.

Return

Historically, ultra short term funds have generated returns around 7% to 9%. They are expected to deliver 6% or slightly more going forward. In comparison to other funds in the debt category, returns from these are slightly higher. However, even though ultra short term funds invest in fixed income instruments, they do not guarantee returns. These funds have an inverse relationship with interest rate movements. In other words, the Net Asset Value (NAV) of the fund tends to fall with a rise in interest rates and vice versa.

Risk

In comparison to other debt funds, ultra short term funds have lower interest rate risks. This is because of the short maturity of the underlying assets. However, the fund manager’s or fund house’s investment strategy might have low credit quality securities with an expectation that they would upgrade in the future. This exposes the fund to credit risk.

Cost

Similar to all mutual funds, ultra short term funds also charge a fee to manage the fund. The fee is referred to as the expense ratio. SEBI has levied an upper limit on the expense ratio to be 1.05%. Therefore, to generate significant returns, investors should consider investing in the fund with a long holding period and low expense ratio.

Tax

Gains from ultra short term funds are subject to tax. On the basis of the investment duration, the gains are subject to short term capital gains tax (STCG) and long term capital gains tax (LTCG). For an investment horizon less than three years, the gains are subject to short term capital gains tax. The returns are added to the investor’s income and are taxable as per the applicable income tax slab rate. On the other hand, investments with a holding period of more than three years, are subject to long term capital gains tax. The returns then are taxable at 20% with indexation benefit and at 10% without indexation benefit. By holding investments for more than three years, investors of the highest tax slab can save tax. This is because the taxation for long term gains is 20% with indexation benefit.

From April 1st 2023, capital gains arising from debt mutual fund investments will be taxable as per the investor’s income tax slab rate, irrespective of the holding period.

Who Should Invest in Ultra Short Term Funds?

Ultra short term funds are ideal for an investment horizon of 3 to 6 months. Investors looking for an investment vehicle to park their excess funds up to a period of 6 months can consider investing in these funds.

Investors who are conservative and prefer getting predictable returns can also invest in these funds. The fund is subject to both credit risk and interest rate risk. Investors who understand this level of risk can also look at investing in this fund.

Ultra short term funds can be used for both short term financial goals as well as Systematic Transfer Plans (STP) in place of liquid funds. Instead of investing a lump sum amount in equity funds, one can invest them in ultra short duration funds and use STP to transfer a certain amount of money to an equity fund. This way, they are earning a return on their debt funds investment. At the same time, they can take advantage of SIP investment in equity funds.

How to Invest in Ultra Short Term Funds?

Investing in ultra short term funds can be done easily through Scripbox. Following are the steps to invest through Scripbox:

1. Visit www.scripbox.com
2. Choose a plan to start investing
3. Create an account (Signup or login)
4. Invest and make online transfers
5. Track investments

Following are the documents required to invest in mutual funds:

• Photograph
• Pan Card
• Address proof (Aadhaar Card (Both Front & Back)/Driving License/Passport/Voter ID Card)
• Identity proof (Pan Card, Aadhaar Card, Driving License/Passport/Voter ID Card)
• Saving account details (including saving account number, branch and IFSC code)

Investments in mutual funds can be made either through a lump sum or Systematic Investment Plan (SIP) route. Scripbox supports investments through both the routes. Additionally, one can use Scripbox’s SIP calculator and lump sum calculator to estimate potential returns from their investments. Moreover, investments through Scripbox are entirely online and paperless. Therefore, one can easily invest and track their investments using the Scripbox account.

Conclusion

Ultra short duration funds are open ended debt funds with a maturity of 3-6 months. The returns they offer are predictable and have comparatively low risk than long duration debt funds. They best suit investors with short term financial goals. Investors can invest in ultra short duration funds through Scripbox, an online platform for mutual funds.

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