Ultra short duration funds are debt-oriented mutual funds that invest money in debt and money market securities for a very short period. Under SEBI rules, these schemes must maintain a Macaulay duration between 3 months and 6 months. Macaulay duration is a way of measuring the average time taken to receive the cash flows from the bonds in a portfolio.

The portfolio of these funds can include instruments issued by companies, banks and the government. The exact mix depends on the fund’s strategy and market conditions.

You can invest in these schemes to park the money that you may need after a few months. For example, if you have ₹50,000 cash saved for buying a laptop in a few months, you can consider a short-term debt fund to park the money instead of leaving it completely idle.

While short duration keeps volatility low, the NAV can still fluctuate due to changes in interest rates, credit events or other market factors. These schemes have a higher credit risk exposure than overnight funds and liquid funds, but lower than low duration funds and short duration funds.

Ultra short duration schemes may suit you if:

• If you want a short-term place for surplus cash: If you have money sitting in your savings account that you don’t need immediately but may need after a few months, these funds can be a good option to consider.
• If you want to gradually move a lump sum into equity: Suppose you want to invest in multi-cap funds or large and mid-cap funds but don’t want to put the entire amount at once, then you can consider this scheme.
• If you want lower duration risk: If you want debt exposure but don’t want to take the same interest rate sensitivity as a fund holding longer-maturity securities, this category may be worth exploring.
• If you have a financial goal coming up in a few months: You may need the money for a planned expense. Putting such money into equity funds can expose you to unnecessary market risk. Ultra-short duration schemes can be useful.

When you invest in ultra short duration mutual funds, the fund manager invests that money in instruments such as commercial papers, certificates of deposit, treasury bills and short-term bonds.

Now the scheme can earn income on those investments in two ways:

• Through interest earned from underlying securities, and
• Capital gains when the bond prices rise.

How does it benefit you? Suppose you park your laptop money of ₹50,000 in an ultra-short duration scheme when its NAV is ₹25. You receive 2000 units (₹50,000/₹25).

Now imagine the portfolio earns an average annual return of around 7%. If returns were exactly 7% and there were no other changes in bond prices, your investment could look roughly like this:

This is only an example. Actual returns can differ due to factors like interest-rate movements, credit events, expenses, and other changes in the portfolio. Also, the schemes don’t promise a fixed 7% return.

Investing in these debt mutual fund schemes can offer you the following benefits:

• Better returns than very short-term options: As these funds invest beyond a few days and weeks, unlike overnight funds and liquid funds, they can take slightly more credit exposure and offer higher returns.
• Comparatively low interest rate sensitivity: The portfolio’s duration, which is between 3 and 6 months, means any changes in interest rates will have less impact on it, compared to longer durations.
• Portfolio transparency: The mutual fund schemes transparently disclose all their holdings periodically. You can check issuers, duration, credit ratings and other details in the fund’s factsheet.
• Can be used alongside equity investments: If most of your long-term investments are in equity funds, then adding a short-term debt fund can give you a separate bucket for near-term money.

Even though these funds have a short duration, they carry certain investment risks, such as:

• Credit risk: These schemes are permitted to invest in money market instruments and corporate bonds. If the issuer defaults, the bond’s value can drop and the fund’s NAV can be impacted.
• Interest rate risk: Although ultra-short-duration funds are less sensitive to interest rate changes, a sudden spike in interest rates can negatively affect the NAV.
• No guaranteed returns: Unlike bank FDs, mutual fund schemes do not promise a fixed return. The fund’s NAV can possibly fall based on market conditions, giving you a lower or even negative return in a short period.
• Reinvestment risk: When securities mature, the fund manager has to invest the money again. If interest rates have fallen during that period, new securities may offer lower interest. Over time, this can reduce the fund’s overall return.

While all these debt schemes are used for short-term investing, they have certain differences. Let’s compare them:

If you prefer slightly longer-duration schemes, you can explore low-duration funds, short-duration funds, or money market funds, where you can invest for 6 months to 3 years.

While picking the best ultra short duration mutual funds, don’t only consider the ones with the highest rate of return. Consider other factors such as:

• Credit quality: Check the fund’s portfolio and the credit ratings of its holdings. A higher yield can sometimes come from taking higher credit risk.
• Portfolio concentration: See how much weight the fund has allocated to each issuer. A well-spread portfolio can reduce dependence on any single borrower.
• Duration: Check the fund’s Macaulay duration and understand how much interest-rate risk you are taking. The longer the duration, the higher the risk.
• Expense ratio: Costs reduce the returns that reach your pockets. Compare expense ratios of similar funds and choose a direct plan over a regular plan for lower costs.

Remember, the best ultra short duration funds consistently perform well across different market conditions, not just over the last 3 or 6 months.

You can invest in an ultra short duration debt fund through the Millions app in a few simple steps:

• Download the Millions app on your smartphone.
• Enter your mobile number and fulfil the KYC requirement.
• Open the mutual funds section and search for ultra-short-duration schemes to compare the curated options based on your goals.
• Select your preferred fund and click on SIP or lump sum.
• Enter the amount you’d like to invest in the scheme and authorise the first payment.

Your investment is set! Check the scheme’s latest portfolio and its duration so you know exactly what you’re investing in. For very short-term needs, you can compare overnight funds and liquid funds. For longer-term goals or wealth building, you can explore equity or hybrid schemes such as multi-cap funds or multi-asset allocation funds.