Funds Intro #3: Ultra short-term Debt funds - A must have inclusion in your debt portfolio


Posted By : Kushal Kothari
Tags :  debt funds wiki

If you've been following our previous two series on Funds Intro, perhaps you will have noticed that we prefer investing in Debt through Mutual Funds than directly investing in FDs or bonds. There are a couple of reasons for the same:

 

1. Access - While access to equity stocks is fairly easy, access to debt securities is not. Most of these debt instruments only trade between large banks, corporates and the only viable way for retail investors to invest in them is via Debt funds

 

2. Liquidity - Even if you directly invest in bonds, you are stuck with them till maturity with no way to sell them off midway. Debt Funds manage their liquidity to facilitate redemptions any day for the investor

 

3. Management - Debt funds may actually be more tricky to manage than equities. Unlike popular perception, debt also has many risks associated with it - Credit risk and interest rate risk being the major ones. A professional manager to look after them is a real value add to a passive debt investor

 

4. Tax - Finally, Debt funds get criminally better tax treatment than their FD or bond counterparts. As mentioned several times before, the indexation benefits is a real boon to reduce your tax liability, especially for a long-term debt investor, especially in the 20% and 30% tax bracket. 

 

While there is a wide variety of debt funds to choose from (we'll write about other categories soon), eventually it comes down to the one that provides the best bargain. Which category provides reasonably high returns while keeping risks low? It is here that many Ultra short term debt funds perform quite well. 

 

Ultra Short Term Debt Funds (UST Debt)

What are they? Funds that invest in Debt instruments, generally with 0.5 - 2 yr average maturity.

 

USP? Get slightly higher interest rates as compared to money market/liquid funds, with good liquidity and moderately low risk. 

 

Where do they invest? Usually, these funds invest in A to AAA credit quality bonds/deposits/structured instruments that mature in up to 2 years. 

 

Why should you invest? While a liquid fund focuses on less risk (due to short maturities), UST Debt funds focus on high returns while still keeping risks relatively low. Even though the interest rate risk is higher than liquid schemes, they compensate sufficiently by providing higher returns. UST debt funds provide a sweet spot of high returns and low risks in debt instruments.

 

Who should consider investing? Anyone looking for a higher returns from debt schemes, without being exposed to high credit and interest rate risks. 

 

While money market/Liquid funds are providing returns ~6.7-7.5% over one year, UST Debt funds are providing average 1-year returns of 8.5-9.25%. Be mindful, UST funds have higher risks than Liquid funds, but in absolute terms, the risks are reasonably low.

 

Hope this helps.

 

Happy Investing!