Given the weak macroeconomic circumstances, with spiraling prices of gold, oil and food items, the year 2011 has started on a somewhat edgy note for Indian capital markets. The inflationary pressure and liquidity squeeze in the banking system (close to about INR 70,000 crore, source: ICICI Prudential Mutual Fund) has resulted in higher interest rates, for borrowers as well as savers. As a result, the fixed income instruments of short-term nature are presently trading at attractive yields.

• Fund Type: Open ended

• Fund Category: Debt

• Risk Rating: 1 – Lower Risk

• Minimum Amount: INR 5,000 – 10,000 (retail plan)

• Tax arbitrage: The dividend income from mutual funds is tax free; albeit the fund house pays a Dividend Distribution Tax (DDT) of 13.84% [in case of non-liquid, debt funds such as Ultra Short Term Funds] before doling out the dividend to the investors.  Even with DDT, investors who pay income tax at 20% or more can opt for dividend option and take advantage of tax arbitrage. The difference in the NAV post dividend declaration will set off capital gains which would otherwise be taxed at your personal income slab as short-term capital gains.

• Redemption: T+1 business day. For example, if you submit the request before 3pm today, then you may get the redemption amount (direct credit/cheque) by the next day but if it gets registered after 3pm, you shall receive the money the day after.

Recommended Funds: as there are more than 40 Ultra Short Term Funds available in the market, We recommend Top 3 Funds

DWS Ultra Short Term Fund: This fund invests in money market instruments, corporate bond papers and fixed deposits. Over 95% of the portfolio is invested in the high credit quality papers (AAA/P+) and rest in AA/P1 papers.

Fund Factsheet (as at 31 January 2011)

• Yield-To-Maturity: 8.40%

• Average Maturity: 0.16 years (approximately 58 days)

• AUM: 456 crores

• Benchmark: Crisil Liquid Fund Index

• Exit load: NIL

Why We Recommend: This fund has always been among the better performing ultra short term funds. It has outperformed its benchmark across 3 and 5 year periods. The fund has generated CAGR return of 6.90% over 5 years as compared to 6.38% generated by the benchmark. Over the 3 year period, this fund has given 6.62% returns in comparison to 6.12% returns from its stated benchmark as at 31 December 2010. The salient feature of this fund is that there is no exit load on this fund. Hence, one can enter and exit the fund without any load.

Birla SunLife Ultra Short Term Fund: This fund has 83.31% of the portfolio in AAA rated instruments and the remaining is invested in Cash and Current Assets.

Fund Factsheet (as at 31 January 2011)

• Yield-To-Maturity: 8.50%

• Average Maturity: 0.12 years (approximately 43 days)

• AUM: 1,543 crore crores

• Benchmark: CRISIL Short-Term Bond Fund Index

• Exit load: For redemption/switch-out <= 15 days from the date of allotment: 0.25% of applicable NAV

Why We Recommend: As at 31 December 2010, this fund has outperformed its benchmark across 6 months, 1 year and 5 year periods but, has underperformed its benchmark in the 3 year period. Over the past 1 year, this fund has given 5.42% returns, while the benchmark has returned 4.7% and over a 5 year period, this fund has given CAGR returns of 7.20%, while the benchmark has given 6.84%.

The fund's expense ratio is 0.31%, as at 30 September 2010 which is much lower than the category average of 0.70%. 

BNP Paribas Money Plus Fund: The fund aims to invest in floating rate debt instruments, fixed rate debt instruments, money market instruments and derivatives. As on 31st January, 2011, about 53.56% of the portfolio is invested in corporate debt, 45.18% in money market instruments (CPs and CDs) and rest in treasury bills and repo instruments.

Fund Factsheet (as at 31 January 2011)

• Yield-To-Maturity: 8.75%

• Average Maturity: 0.29 years (approximately 104 days)

• AUM: 967 crores

• Benchmark: CRISIL Liquid Fund Index

• Exit load: 0.15% shall be charged if units are redeemed /switched-out within 7 days from the date of investment. But, it is NIL in case of switch in between plans/ options of the scheme.

Why We Recommend: The fund has always been among the top performing funds in its peer group for all time periods - 5 year, 4 years, 3 years and so on. As at 31 December 2010, this fund has outperformed its benchmark, Crisil Liquid Fund Index, across all periods. Over the past 1 year, this fund has given 5.54% returns as against the benchmark return of 5.11% and over a 5 year period, this fund has given CAGR returns of 7.25% as against the benchmark return of 6.37%. The fund has expense ratio of 0.64% (as at 30 September 2010) which is lower than the category average of 0.70%

Conclusion

As per the monthly factsheets, the Yield-To-Maturity (the rate of return anticipated on the fund if it is held until the date of maturity) of most of the Ultra Short Term Funds is currently at much higher levels than the 3.5% return from savings account. Also, since the portfolio of these funds is composed of money market instruments i.e. CDs and CPs and corporate bonds, the credit profile varies across AAA and AA rated for corporate papers, PR+, P1+, P1 rating for CDs and CPs which are well rated.

Hence, these products can be considered by retail investors as they not only offer good post tax returns and easy liquidity but also are less volatile than equity asset class in the intermediate period. Thus, Ultra Short Term Funds work as a good investment product for short-term horizon than the traditional savings account deposit. 

Related Article: Answer to Intermediate Investing: Ultra Short Term Funds

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