Benefit from rising interest rates with ultra short term funds

Most of us have surplus money parked in a bank savings account waiting to be used for some unpredictable expenses.

It is also one of the safest places to keep your money, because we are more than happy as our principal is safe and liquid and is earning at least 4% interest.

Very few investors are aware of an equivalent option in the mutual fund space via debt funds, particularly short-term funds.

Ultra short term funds, or liquid plus funds, have emerged as preferred vehicles for investors to ride out rising interest rates.

The ultra short term focuses on very short-term instruments in the fixed-income space. Ultra-short bond funds offer investors greater protection against interest rate risk than longer-term bond investments.

Since these funds have very low durations, increases in the rate of interest will have a lesser impact on their value, vis-a-vis a medium or long-term bond fund. It invests most of the money in call money and other short-term instruments, offering good liquidity.

The fund manager builds a diversified portfolio of fixed-income instruments with varying maturities.

The portfolio comprises treasury bills issued by Government of India, commercial papers issued by corporates, certificates of deposits issued by banks, securitised debt and advances in the call money market that matures between 90 and 365 days. If the interest rate appreciates,  the value of the fund falls and if the interest rate falls, then the value of the fund rises.

Of course, public sector banks have also been hiking the interest rates on their fixed deposits. But the returns offered by short-term financial securities are higher than fixed deposits offered by large banks for a similar tenure, which makes the fund route relatively attractive. Also, once the investor invests in fixed deposit he is locked in it. If the interest rate keeps rising, it will be difficult for him to capture the higher interest rate unless he breaks the current fixed deposit to get into a new fixed deposit.

But if the investor invests in ultra short term funds, he can hope to capture the higher interest rates that may be on offer. The aim of ultra short term fund as a mutual fund product is to provide reasonable returns in the short term, as well as offer liquidity.

These funds typically give 4.5% to 7% annualised return.  An investor looking to invest in these funds, with less than one year timeframe in mind, should ideally go for the dividend option to ensure better post-tax returns.

PRINCIPAL Near-Term Fund - Conservative
PRINCIPAL Near-Term Fund - Conservative is an open ended scheme with the objective to maintain a sensible mix of cash, short-term and medium-term instruments.

The fund is been managed by Akhil Mittal since December 2010. It was launched in September 2004. The fund has invested in a wide variety of debt securities and more than 90% of the portfolio is in certificate of deposits and commercial papers. The fund’s average maturity and modified duration as of February 2011 was 16 days. The fund had delivered positive returns in every quarter.

The fund has reduced its allocation under NBFCs from 23.87% in January 2011 to 17.35% in February 2011. The fund has also reduced its investments in floating rate bonds over the last seven months. The fund has always been among the better performing ultra short term funds. In 1 month, it had delivered 8.21% against its benchmark, which stood at 8.03%.

Templeton India Ultra Short Bond Fund - Retail
The fund was launched in December 2007 and is currently been managed by Pallab Roy. The fund aims to provide a combination of regular income and high liquidity by investing primarily in a mix of short term debt and money market instruments. The fund has invested more than 80% of the portfolio in AAA and equivalent securities and less than 3% in below AAA instruments for the last six months. The expense ratio of 0.65% ensures that the cost of fund does not eat into your profit. 

In two months, the scheme delivered simple annualised returns of 8.04%, while the category average stood at 8.10% and the benchmark delivered 7.76%. In one year, it delivered 6.18% of compounded annualised return compared to its benchmark which was 5.88%. The scheme has outperformed its benchmark index across all periods- 1 month, 3 months, 6 months and 1 year.  The average maturity of the fund is 33 days as on January 2011.

HDFC Cash Mgmt Fund - Treasury Advantage - Ret
It is an open ended scheme, which provides investments in money market and corporate debt instruments. The investment plan is suitable for investors who have short- to medium-term investment horizon.

The fund is managed by Anil Bamboli since September 2007, who has around 10 years of experience in research. The fund was launched in November 1999. The sharpe ratio of this scheme is 5.06. For the last six months, the fund has invested more than 50% in certificate of deposits and less than 3% in commercial papers and more than 30% in cash.

The fund has underperformed by delivering 6.93% in 6 months against the benchmark, which was 7.04%. Though, in the span of 1 year, it has generated 6.04 compound annualised returns against 5.88% its benchmark, whereas the average maturity and modified duration is 27 days and 24 days respectively for February 2011. The scheme has no exit load.

This fund offers the investors safety and return potential similar to liquid fund with a lower tax incidence and for those investors seeking high levels of liquidity for their investments.

IDFC Ultra Short Term Fund
IDFC Ultra Short Term Fund is an open ended scheme with the inception on January 2006. The investment objective of the scheme aims to provide high liquidity by investing in a portfolio of money market instruments and debt instruments. The fund is managed by Anupam Joshi. For the past six months, the fund was actively investing in certificate of deposits more than 70%, but for the last one month, it has reduced its investment in certificate of deposits, which is less than 25%. The fund has started investing in floating rate bonds for the past two months.

The fund has performed extremely well for all the periods compared to its peers. In 3 months, it has generated 8.29% returns compared with its benchmark which was 7.67%. The scheme has an exit load of 1%, if the scheme is redeemed between 0 days to 31 days.