Making sense of Short Term Debt Mutual Funds

This is the 5th post in the debt mutual fund investing series. You can find all the earlier posts here:

Part 1 – A primer for investing in debt mutual funds (Link)
Part 2 – 8 factor framework for analyzing any debt mutual fund (Link)
Part 3 – The ultimate guide to liquid funds (Link )
Part 4 –
Here’s a quick way to select Ultra Short Term Funds (Link )

Short Term Funds:

Short Term funds generally invest in debt securities with maturities ranging between 1 to 3 years. In other words the money is lent to different companies, banks, NBFCs ,government etc for 1 to 3 years. Since the tenure of lending is slightly higher for Short term funds compared to Ultra Short Term Funds and Liquid funds, most often we get marginally higher returns (which will be reflected in a slightly higher YTM)

I use this category of funds when my  investment horizon is more than 2 years and safety of capital is the priority. Think of this more like a decent alternative to Fixed Deposits.

These funds can take two risks to generate additional returns

  1. Interest rate risk
    The funds take a moderate interest rate risk to improve returns and mostly have a modified duration ranging between 1 to 3 years. So there is a possibility of higher returns if interest rates decline and vice versa. Most of them keep varying their modified duration within the range based on their interest rate view i.e will reduce the modified duration if the fund manager expects interest rates to go up and increase the modified duration if he expects the interest rates to go down. Some short term funds are more conservative and move the modified duration between 1-2 years while slightly aggressive ones move between 1-3 years modified duration.
  2. Credit Risk:
    In addition to the moderate interest risk , within the category, there are funds which additionally take credit risk as a strategy and those which avoid credit risk. Personally, I don’t like to take credit risk in my debt portfolios. I take risks via my equity portion and I am not too comfortable taking credit risk in my debt portion where “return of capital” is the priority over “return on capital”. Hence I first check for these funds which take credit risk and remove them from my list. But for investors who clearly understand credit risk and are willing to take the risk to generate additional returns, they can consider those funds which take credit risk (which is reflected in a higher YTM).

How to choose a Short Term fund ?

If you have gone through the earlier post on choosing Ultra Short Term funds (Link ), then you will be familiar with our simple approach – find funds with reasonable size, minimal credit risk, moderate interest rate risk and proven fund management teams.

As in the previous post we will be using the excel report from MOSL Research called Most MF Daily Score Card. You can download it here. (You need to create a login. No worries, it is free only)

There are a total of 58 Funds classified as Short Term funds.

Step 1: Knock off all schemes less than 1000 cr: 26 funds get knocked off and we are left with 32 funds.

Step 2: To check for credit quality – Knock off all schemes with % of AAA+ Sovereign + Call & Cash < 80%
Another 10 funds get knocked off and we are left with 22 funds

Step 3: Knock off funds with modified duration greater than 3 year
You can keep your own cut off here. I end up removing another 4 funds and I am left with 18 funds.

Step 4: Sort it according to 3Y returns and observe the max and min returns

Range of return outcomes:
3Y = 9.0% to 10.3%

Putting that in perspective, for every 1 lakh you invest in Short Term Funds the difference between the lowest and highest return fund in our final list in the last 3 years works out to be ~Rs 4,700. As expected the outcome ranges are pretty narrow and even if you end up with the lowest return fund it is definitely not catastrophic!!

So once we have arrived at this stage – we shall remind ourselves of the “paradox of choice” and instead of getting into analysis-paralysis our aim will be to find a “good enough” fund !!

Step 5: Stick to major AMC’s with reasonable track record and good debt fund management teams

I generally prefer funds from IDFC, ICICI, HDFC, Reliance, Axis, Birla Sun Life. Of course, that being my preference, you are free to pick any fund within these 18 schemes. Some schemes that I like are 1)IDFC SSIF – Short Term, 2)Birla SunLife Short Term Fund, 3)Axis Short Term Fund and 4)Kotak Bond Short Term Plan.

Short Term FundsSource: Morningstar, Value Research

In our next post, let us analyse the pros and cons of taking up credit risk to improve returns in debt fund portfolios.

Happy investing folks🙂

Disclaimer: No content on this blog should be construed to be investment advice. You should consult a qualified financial advisor prior to making any actual investment or trading decisions. All information is a point of view, and is for educational and informational use only. The author accepts no liability for any interpretation of articles or comments on this blog being used for actual investments


9 thoughts on “Making sense of Short Term Debt Mutual Funds

  1. Pingback: Newsletter week 2
  2. Tahnk you for your lovely blog. One calrification on this – short term funds have marginally higher returns but do take an interest rate risk for this. Would not trying to hold money in a liquid or UST fund (rather than ST) for 3 years be much better than an FD especially if one is in the 30% tax slab and wants least risk as well?


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