Struggling to balance risk reduction with the need for consistent short-term returns?
Short-term funds can be an effective solution. These funds help safeguard wealth while providing steady income, serving as a hedge against the volatility often associated with long-term investments.
In this article, we’ll look at what is short duration fund, its features, advantages, and associated risks.
What is a Short-Duration Fund?
A Short Duration Fund is a type of debt fund that primarily invests in short-term debt instruments and money market securities.
According to SEBI’s classification norms for mutual fund schemes, these funds must maintain a Macaulay duration of one to three years in their portfolios. Macaulay duration indicates how sensitive the portfolio is to interest rate changes, reflecting the risk of fluctuations in the value of debt securities due to market interest rate movements.
Since the investment duration is between one and three years, these funds generally carry a low to moderate interest rate risk.
Benefits of Short-Duration Funds
Now that you know what is short duration fund, let’s see what benefits you can expect by investing in it.
1. Lower Interest Rate Risk
Short-duration funds carry lower interest rate risk because they hold bonds and other securities that have shorter maturities—generally up to three years.
When interest rates increase, the value of securities typically declines, but not as much for short-term securities. That means investors in short-duration funds aren’t likely to experience substantial losses of principal due to increases in interest rates.
2. Stable Returns
These funds offer consistent and relatively predictable returns which makes them appealing to conservative investors. Since they invest in short-term debt instruments, they are less vulnerable to market volatility.
This stability helps investors minimize significant fluctuations in their investments, making it especially important for those seeking safer options.
3. Liquidity
Short-duration funds often have strong liquidity, enabling investors to redeem their holdings quickly. This characteristic makes them ideal for investors who want access to their funds in a short period, as opposed to longer-term investments requiring several years.
4. Diversification
Short-duration funds diversify across government securities, corporate bonds, and money market instruments. This mix helps reduce overall portfolio risk.
Risks of Short-Duration Funds
While Short-duration funds are generally considered lower risk compared to long-duration funds, they still come with certain risks:
1. Credit Risk
There’s a chance that the companies issuing bonds may not be able to pay back their debt. This could happen if they face financial difficulties or go bankrupt.
When investing in short-duration funds, if these lower-rated bonds are included in the portfolio, the risk of default increases.
If a bond defaults, it can result in losses for the fund, impacting the returns for investors.
2. Interest Rate Risk
Interest rates can affect the value of bonds held in short-duration funds. When interest rates increase, new bonds are issued with higher rates, making existing bonds less appealing. This causes their prices to drop.
Since short-duration funds invest in bonds that mature within 1 to 3 years, any increase in rates can lead to a decline in the fund’s value.
This means that investors could see lower returns if they need to sell their investments during times of rising interest rates.
3. Reinvestment Risk
When bonds in a short-duration fund mature, the fund needs to reinvest the money. If interest rates are lower at that time, the new bonds will offer lower returns than the previous ones.
For example, if a bond that pays 6% interest matures and the fund has to reinvest at only 4%, the overall returns decrease.
This situation, known as reinvestment risk, can impact the income generated by the fund, making it important for investors to consider.
Who Should Invest in Short-Duration Funds?
Short-duration funds can be a suitable investment option for various types of investors. Here are some groups that might benefit from investing in these funds:
1. Conservative Investors
Short-duration funds are a good fit if you have a low-risk tolerance and seek stable returns over a short period. These funds strike a balance between risk and return, making them ideal for conservative investors.
2. Investors with Short-term Goals
Short-duration funds work well if you have specific financial goals to achieve within a short span. Whether you’re purchasing a car or planning a dream vacation, these funds are designed for short-term goals.
3. Diversification Seekers
Adding short-duration funds to your investment mix benefits those looking to diversify their portfolio. By combining debt and equity, you can reduce overall risk exposure. It reduces the overall risk of the portfolio.
5 Short Duration Funds in India
To invest, here are five short-duration funds in India along with their key details:
| Fund Name | NAV (₹) | AUM (₹ Cr) | Expense Ratio (%) | 5-Year Return (%) |
| ICICI Prudential Short-Term Fund | 61.47 | 19,746 | 0.45 | 7.71 |
| HDFC Short-Term Debt Fund | 31.01 | 14,382 | 0.40 | 7.25 |
| Aditya Birla Sun Life Short-Term Fund | 48.24 | 8,759 | 0.38 | 7.41 |
| Axis Short-Term Fund | 31.53 | 9,094 | 0.36 | 7.15 |
| Nippon India Short-term Fund | 53.68 | 6,945 | 0.37 | 7.21 |
Conclusion
Short-term funds are an attractive investment option for investors seeking consistent returns with lower risk. However, investors should consider their specific goals and overall risk tolerance level before selecting a mutual fund.
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