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What is a short duration fund?

Short duration funds are ideal for investors who are aiming for a 1-3 year investment horizon in relatively safer instruments. These funds are created to hold capital for longer than liquid funds, but for much shorter than most retirement funds.

In this article, we’re going to delve deeper into the workings of these funds, understand what types of investors need them, and how you can use them to diversify your portfolio well.

Understanding short duration funds

Short duration funds are a category of debt mutual funds in India that primarily invest in fixed-income securities with relatively short maturities. These funds aim to strike a balance between generating higher returns than traditional savings accounts or fixed deposits and, at the same time, making sure that they have low risk.

These funds typically invest in fixed-income securities like corporate and government bonds, along with other money market instruments. Short-term debt is also sometimes considered depending on the fund manager.

The aim is to capitalise on opportunities in the fixed-income market while managing interest rate risk by focusing on securities with relatively short maturities.

Here are some other characteristics of short-duration bonds:

  • Lower interest rate risk – Unlike long-duration debt funds, which are highly sensitive to changes in interest rates, short duration funds have lower interest rate risk because they invest in shorter duration bonds and securities. As is obvious, there is a greater risk that interest rates will change (favourable or otherwise) over a long period of time than a shorter one. It is this difference that allows them to offer relatively stable returns and lower NAV volatility to investors compared to longer-duration funds.
  • Liquidity and redemption – Short duration funds typically offer higher liquidity, allowing investors to redeem their units at any time during market hours. Money is also usually credited to the investor’s bank account within a short period, making this investment suitable for investors who might need cash with little to no notice.

Who should invest in short-duration bonds?

Relatively conservative investors who are ok with settling for lesser returns in return for lower risk should consider investing in short duration bonds. Since these funds invest in debt, they are more stable and maintain capital better than equity.

Income investors also sometimes invest in these funds because debt usually pays out a fixed and predictable dividend regularly, which can become a form of passive income to investors. However, there are several income generation funds which specifically target regular income streams for investors, which could be a better bet if you’re targeting that.

Diversification is also a big one, which is especially important if you’re only invested in equity or alternative investments like cryptocurrencies or digital art. These funds might help reduce the volatility of your entire portfolio quite a bit.

Short duration funds in India

Here are some funds you might consider researching if you want to invest in short-duration funds:

  • HDFC Short Term Debt Fund:
    Average returns: 7-8% (as of 2022)
    Securities held: HDFC Bank, Reliance Industries, ICICI Bank, etc.
  • ICICI Prudential Short Term Fund:
    Average returns: 7-8% (as of 2022)
    Securities held: Infosys, State Bank of India, Tata Motors, etc.
  • Aditya Birla Sun Life Short Term Opportunities Fund:
    Average returns: 7-8% (as of 2022)
    Securities held: Larsen & Toubro, Axis Bank, Power Finance Corporation, etc.
  • SBI Short Term Debt Fund:
    Average returns: 7-8% (as of 2022)
    Securities held: Indian Oil Corporation, NTPC Limited, HDFC Ltd., etc.
  • UTI Short Term Income Fund:
    Average returns: :Securities held:ns: 7-8% (as of 2022)
    Securities held: Tata Steel, Mahindra & Mahindra, Grasim Industries, etc.

Frequently Asked Questions

Can I redeem my investment in short-duration funds anytime, and how quickly can I access my funds?

Short-duration funds offer high liquidity, allowing you to redeem your investments at any time during market hours. 

What role do interest rate movements play in short-duration funds, and how do they impact returns?

Interest rate movements have a significant impact on short-duration funds as they affect the yields of the underlying fixed-income securities. Generally, when interest rates rise, bond prices fall, leading to a decrease in NAV for short-duration funds. 

Are short-duration funds suitable for income generation, and how do they compare to dividend-paying stocks or fixed-income instruments?

Yes, short-duration funds can serve as an income-generating investment option, primarily through periodic dividends distributed to investors. While they offer potential income, you should compare the yield and risk profile of short-duration funds with dividend-paying stocks and fixed-income instruments to get a more accurate picture.

Can I expect stable returns from short-duration funds, or are they subject to market fluctuations?

While short-duration funds aim to provide stable returns, they are still subject to market fluctuations, although to a lesser extent compared to longer-duration funds.

How do short-duration funds differ from other types of debt funds like ultra-short duration or long-duration funds?

Short-duration funds typically have a moderate risk profile compared to ultra-short duration funds, which are even shorter in duration, and long-duration funds, which have longer durations and higher interest rate risk.

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