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    Are your ultra short duration funds really 'ultra short'?

    Synopsis

    The Franklin Templeton Mutual Fund episode revealed that not all ultra-short duration funds are really “ultra-short.”

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    By Rushabh Desai

    “Ultra-short” duration funds are meant to invest in very short-term fixed income instruments. The average maturity of the funds in the category ranges between three to 12 months. This is why the category is suitable for investors looking to park their money for three to six months, mainly to fulfil their short-term financial needs. Of course, the investor can stay invested for more time if he/she wishes.

    However, the Franklin Templeton Mutual Fund episode revealed that not all ultra-short duration funds are really “ultra-short.” Sure, the average maturity of the funds looks very much in line with the category mandate, but one should understand that it is only the weighted average of the maturities as per the allocation in the overall portfolio. The truth is that the actual maturity profile looks very different and many instruments in the portfolio have maturities beyond the average maturity period.

    The data below clearly shows that many funds have a large portion of their portfolio in instruments with maturities way beyond one year. Remember, “ultra-short duration” funds should typically have most of its investments in maturities of maximum of up to one year and carry a very healthy credit profile. As per Sebi definition, these funds must invest in instruments with a Macaulay duration of three to six months.

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    What does this mean for investors?
    As you would remember, Franklin Templeton Mutual Fund was forced to shut six of its debt schemes, including a ultra short duration scheme, recently. The AMC had to take this step because it was unable to liquidate the instruments to meet the extra redemption pressure. It could not sell its investments in its ultra-short duration fund mainly due to two reasons: One, it had a large allocation to low credit-rated instruments. Two, it also had a large allocation towards instruments maturing beyond the one-year bracket.

    Many inventors were shocked to see the maturity profile of the ultra short duration fund. It had 50% of its investments in instruments with maturities of one to five years. That means these investors in these “ultra-short” funds will have to wait probably for a long time to get their money back. Note, most investors may have parked their money in the fund to meet their short-term financial needs.

    As you can see, it is of utmost concern and high importance that an ultra-short investor should understand the credit and the actual maturity profile of an ultra-short duration fund before investing. In these unprecedented times when redemptions are climbing up one may never know when another scheme may be shut and investors may have to wait for years to recover their money back.

    What should investors do?
    The Covid-19 lockdown extensions are slowly drying up all the earnings and the ultra-short duration funds may see further redemptions and (downgrades in their low credit quality instruments). This combination can hurt investors badly. Thus, it is always better to be safe than sorry when it comes to the debt portion of the money, especially the one you need for short-term financial needs.

    Capital preservation should be the top priority while choosing any debt mutual fund. Investors should diversify well and choose ultra-short duration funds mainly based on a combination of four parameters:

    1. The overall maturity profile ( at least 80%) of the fund should be one year.
    2. The cash flows of its instruments should be in line with the maturity profile.
    3. The fund should have a very high credit profile of 100% or close to 100% in sovereign, cash and AAA-rated instruments.
    4. The quality and the experience of the AMC and the manager should be high - they should be able to handle difficult times like these with ease.
    (Rushabh Desai is an AMFI-registered mutual fund distributor based in Mumbai.)
    (Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
    The Economic Times

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