Ultra Short Duration Fund
An ultra short duration fund is an open-ended debt mutual fund with a portfolio Macaulay duration of 3 to 6 months, positioned between liquid/money market funds and short duration funds on the risk-return spectrum.
SEBI's categorisation norms specify a Macaulay duration band of 3–6 months for ultra short duration funds. The Macaulay duration metric represents the weighted average time (in years) that an investor waits for cash flows from the portfolio — both coupons and principal repayments — to be received. A shorter Macaulay duration implies lower sensitivity to interest rate changes (lower modified duration), making ultra short funds relatively resilient during rate-hiking cycles compared to longer-duration categories.
Ultra short duration funds typically invest in a blend of money market instruments maturing within 3–12 months, short-term corporate bonds and non-convertible debentures (NCDs), certificates of deposit (CDs) from banks, and Treasury bills. Unlike liquid funds, which are capped at 91-day instrument maturities, ultra short funds can hold instruments with maturities beyond 91 days, enabling them to earn a modest yield premium over the liquid fund category.
The category gained widespread retail adoption in India as a step-up from savings bank accounts and liquid funds for investors with a 3–12 month investment horizon. Corporates use these funds for working capital surpluses, while retail investors use them as a cash management tool or as the target scheme for systematic transfer plans (STPs) from which equity fund SIPs are funded.
Credit quality in ultra short duration funds can vary significantly across fund houses. Some AMCs maintain a predominantly AAA-rated and sovereign portfolio, while others have historically ventured into AA and occasionally A-rated paper to enhance yields. The latter approach introduces meaningful credit risk. Several funds in this category faced sharp NAV drops following credit events involving IL&FS (2018), DHFL (2019), and YES Bank bonds (2020), drawing regulatory attention to credit risk practices in ostensibly "safe" short-duration categories.
SEBI subsequently tightened valuation norms and mandated side-pocketing provisions across all debt categories to improve transparency. Ultra short duration funds now display portfolio credit rating distributions prominently in factsheets, enabling investors to compare credit risk across AMCs.
Post Finance Act 2023, gains from units purchased on or after 1 April 2023 are taxed at the investor's income tax slab rate, removing a key tax advantage these funds previously held over bank fixed deposits for investors in higher tax brackets.