Short Duration Funds

Short duration funds are debt funds that invest in short term debt securities with Macaulay duration of the portfolio between one year to three years. Macaulay duration gauges a portfolio's sensitivity to interest rate risk.

Short duration funds are ideal if you are looking for a combination of:

• Regular Income
• Decent Returns*

*The returns of short duration funds are less sensitive to interest rate fluctuations.

Additionally, these funds are ideal for short investment horizons like one to three years. 

If you have a shorter investment horizon, other debt fund categories like money market funds, overnight funds and liquid funds can be considered to keep risks in check.

On the other hand, for longer investment horizons, you can consider long term debt, aggressive debt, hybrid and equity funds with higher return potential.

Short duration funds primarily invest in corporate bonds, bonds issued by financial institutions and public sector units (PSUs), government securities, securitised debt, and derivatives.

Part of the funds may be allocated to highly liquid money market instruments like Treasury Bills (T-Bills), Commercial Papers (CPs), and Certificates of Deposits (CDs) to counterbalance the risk.

Professional Management of Your Money

The instruments that short duration funds invest in are also available to retail investors for investment. But there are two problems:

The minimum ticket size of each instrument may be as high as Rs. 10 lakh

Not everyone understands the nuances and functioning of debt markets

By investing through short duration funds, both problems are solved. You can invest in short duration funds with amounts as low as Rs. 500 and also avail professional management to save time and effort and avoid potential mistakes.

Safety and Stability

As we saw, short-duration funds typically invest in securities with shorter maturity periods (typically ranging between 1 to 3 years). This makes them less sensitive to interest rate fluctuations compared to longer-duration investments. 

The average credit quality of most short duration funds is AAA. This means that most securities that the short duration funds invest in are of the highest credit quality, which reduces ‘credit risk’, the other major risk of investing in debt instruments.

Source: Valueresearch | As of Jan, 2024

Because of the low interest rate and credit default risks, money market funds offer safety and stability of returns.

As the name suggests, short duration funds are ideal short-term investments (1 to 3 years) because of their liquidity and stability of return.

Here are a few scenarios we feel short duration funds may fit well in:

Fixed Deposit Alternatives

Most fixed deposits are booked for a few months to a couple of years, the timeframe for which short duration funds are ideal for investments.

Short duration funds can potentially deliver better returns than fixed deposits and are taxed only when redeeming them.

However, fixed deposits of up to Rs. 5 lakh per depositor per bank are insured by Deposit Insurance and Credit Guarantee Corporation (DICGC). Short duration funds, although low risk, are not insured. But, these funds are regulated by SEBI (Securities and Exchange Board of India).

Diversification

Short duration funds contribute to portfolio diversification by investing in various assets, such as government and corporate bonds, treasury bills, and other money market instruments.

Adding debt funds (short duration and/or other funds) is a great way to manage your portfolio risk.

Emergency Fund Requirement

Short-duration funds often invest in highly liquid instruments. This ensures easy buying or selling of the units, providing liquidity when needed.

While providing some regular income, short-duration funds also focus on preserving capital. This benefits those prioritising capital protection while seeking returns higher than traditional savings or fixed deposit accounts.

Because of high liquidity and capital protection with decent returns, short duration funds are ideal for holding your emergency funds.

STCG on Short Duration Funds

For short duration funds, STCG or Short Term Capital Gains are gains registered within 3 years of investment.

• For investments made before 1st April, 2023: All gains registered within 3 years from investment are taxed at your marginal income tax rate.
• For investments made after 1st April, 2023: Unchanged

LTCG on Short Duration Funds

For short duration funds, LTCG or Long Term Capital Gains are gains registered after 3 years of investment.

• For investments made before 1st April, 2023: All gains registered after 3 years from investment are taxed at a 20% flat tax rate with the benefit of indexation.
• For investments made after 1st April, 2023: From 1st April onwards, all debt capital gains lose LTCG and indexation benefits and will be taxed like STCG - at your marginal income tax rate.

Dividend Distribution Tax on Short Duration Funds

You receive dividends when you invest in the IDCW (Income Distribution Cum Withdrawal) option.

Dividends received are taxed at your marginal income tax rate.

TDS (Tax Deducted at Source) at 10% is applicable on dividends received in excess of Rs 5,000 per AMC per financial year.