Can you bet on ultra-short, low duration funds for short-term needs?

Investors are putting money in ultra-short and low-duration funds as they anticipate hikes in policy rates by RBI in the coming months. According to data released by the Association of Mutual Funds in India (Amfi) for October, investors shifted their focus to overnight, ultra-short and low duration funds from liquid funds.

Overall, overnight (inflow of Rs 6,337 crore), ultra-short (Rs 4,511.77 crore) and low duration debt funds (Rs 4,202.96 crore) witnessed inflows of about Rs 15,000 crore in October.

Investors park money in these funds for the short term, ranging from a few days to a few months.


According to debt mutual fund managers, investors are turning to these short-term funds for stable returns as they believe the central bank may start hiking rates soon.

"If inflation remains elevated then RBI may revisit the accommodative stance which it has adopted to support growth. I believe investors are sitting with higher allocations to low duration funds for stable returns and lower volatility," said Akhil Chaturvedi, Chief Business Officer, Motilal Oswal Asset Management Company.

Lakshmi Iyer, CIO (Debt) and Head of Products, Kotak Mahindra Asset Management Company, pointed out investors, who have a shorter investment horizon find these funds suitable for their investment goals.

"Some investors seem not very content with the returns of the liquid fund. Also, they may not have a very long investment horizon and that’s where the low duration category fits in. Those having an investment horizon of more than six months could look as this category," Iyer observed.

Should you invest?

Many investors and advisors believe that a rate hike may drag debt funds further down. They believe bank deposits are better at this juncture.

"Liquidity and rate normalising cycle are likely to be a gradual one hence the case for earnings in fixed income still remains. While we could see volatility in the coming months, one could still stay invested across debt funds based on the investment horizon," said Iyer.

Unlike long-term debt funds, very short term funds like ultra-short-term and low-duration debt funds are less likely to be hit by hardening rates. In fact, they may benefit marginally from rate hikes because they will start investing in papers with higher coupon rates.

Debt funds, especially long term funds and gilt funds, suffer when interest rates go up because it drags down the NAV of these funds. This is because of the inverse relationship between bond yields and prices. When bond yields go up, the prices and NAV of schemes come down.

According to Chaturvedi, fixed-income investors should remain at the shorter end of the yield curve in the medium term. "It would be prudent for retail investors to avoid taking any aggressive call on interest rates or credit," said Chaturvedi.

Fund managers ask investors not to change the investment strategy based on market conditions alone but on one's financial goals and risk appetite.

"The key for every investor is to stick to asset allocation and not deviate from that path even during volatile times. There are strategies in fixed income to suit various rate cycles. Hence, the key is to identify such categories without losing sight of one’s risk appetite," said Iyer.