Short-duration funds: Ideal for low-risk investors with goals 1-3 yrs away

Union Mutual Fund recently launched the Union Short Duration Fund, an open-ended short-duration debt scheme. Its new fund offer (NFO) opened on January 15 and will close on January 28, 2025. Short-duration debt funds have gained popularity among investors for their ability to provide accrual income and their moderate sensitivity to interest rate changes. According to the Association of Mutual Funds in India (Amfi), 23 short-duration funds collectively managed assets worth Rs 1.13 trillion as of December 31, 2024. 

Short-duration funds defined 

According to the Securities and Exchange Board of India (Sebi), these funds must maintain a portfolio Macaulay duration between one and three years. “They invest in instruments with maturities between one and three years,” says Murthy Nagarajan, head-fixed income, Tata Asset Management. 

 

They are different from corporate bond funds and banking PSU funds. “While these funds have restricted investment choices but no limits on maturity periods, short-duration funds’ portfolio Macaulay duration is limited to three years,” says Joydeep Sen, corporate trainer and author. 

Balanced approach   

Short-duration funds are relatively low-risk investments. “They tend to be less volatile than funds with a higher duration,” says Puneet Pal, head-fixed income, PGIM India Mutual Fund. They combine the benefits of accrual income with some possibility of price appreciation. “They perform well in environments with stable or declining interest rates,” says Nagarajan. 

Sen adds: “These funds perform well when interest rates are coming down as they benefit from both the portfolio yield to maturity (YTM) and market gains.” Short-duration funds lose less than long-duration or gilt funds in a rising interest rate scenario. Sen highlights another advantage: fund houses maintain high portfolio quality in this category. 

Lower benefits from rate cuts   

These funds are less suited for investors seeking capital appreciation. “If you are looking for gains from interest rate cuts by the Reserve Bank of India (RBI), short-duration funds might offer limited benefits compared to longer-maturity funds like gilt or long-duration funds,” says Sen. These funds may underperform liquid and money market funds in a rising rate environment. 

Why invest now? 

Short-duration funds, according to experts, are well-positioned to benefit from active duration management in the current economic scenario. “India’s economy is in an expansion phase, with inflation within the RBI’s tolerable range and the possibility of shallow rate cuts if growth moderates,” says Manish Banthia, chief investment officer-fixed-income, ICICI Prudential Mutual Fund. He adds that short-duration bonds, particularly AAA- and AA-rated corporate bonds, currently offer attractive spreads. 

Should you go for them? 

Investors with a low to medium risk appetite may consider short-duration funds, according to Pal. “They are ideal for short-term financial goals like children’s education or a down payment for a house. They are also useful for transitional savings, such as during job switches or while starting a business,” says Nagarajan. 

According to Sen, investors with a two-to-three-year horizon may consider these funds, but not those with a horizon of three to six months. Pal recommends a minimum horizon of 12 months.