Ultra Short vs Low Duration Funds: Which Suits You
The difference is written into SEBI’s scheme categorisation rules. An ultra short duration fund must run a Macaulay duration of 3 to 6 months. A low duration fund must run a Macaulay duration of 6 to 12 months. Everything else about the two categories follows from that one number.
Macaulay duration is the weighted average time, in years, until you receive a bond’s cash flows. SEBI uses it as the yardstick for bracketing debt categories, because it captures both maturity and the timing of coupons in a single figure.
Longer duration means more yield in normal conditions and more price movement when rates change. That is the entire trade off between these two categories.
What duration does to your NAV
The practical number to watch is modified duration, which the factsheet reports alongside Macaulay duration. The rough working rule is simple: NAV change is approximately modified duration multiplied by the change in yields, with the sign flipped.
Take an example. An ultra short fund with modified duration of 0.4 faces a 50 basis point rise in short term yields. The price impact is roughly 0.4 times 0.5, which is about 0.2 percent. A low duration fund with modified duration of 0.9 takes about 0.45 percent. Both are small, and accrual at current short term yields would recover the difference within weeks.
Flip it around in a rate cutting cycle and the low duration fund gains a little more. The gaps are modest either way, which is why arguing about these two categories on rate views is mostly wasted effort.
Side by side
| Feature | Ultra short duration | Low duration |
|---|---|---|
| SEBI rule | Macaulay duration 3 to 6 months | Macaulay duration 6 to 12 months |
| Typical horizon | 3 to 6 months | 6 to 18 months |
| Rate sensitivity | Very low | Low but higher than ultra short |
| Yield | Usually a shade lower | Usually a shade higher |
| Exit load | Often nil, verify in the scheme document | Sometimes a short load period |
The risk that duration does not measure
Here is the misconception that has cost Indian investors real money. Duration tells you interest rate risk. It says nothing about credit risk.
Two ultra short funds can both sit at 5 months Macaulay duration while one holds only treasury bills and top rated bank certificates of deposit and the other holds lower rated commercial paper for extra yield. During the IL&FS and DHFL episodes of 2018 and 2019, several short maturity funds took sharp single day NAV hits, not because rates moved but because holdings were downgraded or defaulted.
So read two things in every factsheet:
- Rating breakup: what share is sovereign and highest rated, and what share sits below that.
- Potential risk class matrix: SEBI requires every debt scheme to display a grid cell showing maximum credit risk and maximum interest rate risk. A fund in a high credit risk cell can move there whenever the manager chooses, even if today’s portfolio looks clean.
A fund promising a yield noticeably above its peers in these categories is almost always taking credit risk, because there is no other lever available at such short maturities.
How to choose between them
- Start with your date. Money needed within six months fits ultra short. Money you can leave for a year or more fits low duration.
- Check the exit load. Some low duration schemes charge a load for redemption within a few days or weeks, which can wipe out the yield advantage on short holdings.
- Compare direct plan expense ratios. On a portfolio yielding around 7 percent, a 0.5 percent cost difference is a seventh of your return.
- Look at the rating profile, not the past return. The top performing fund in these categories over one year is often the one holding the most credit risk.
- Do not stack both. Owning one of each rarely adds anything, since the portfolios overlap heavily.
Both categories are debt schemes for tax. The rules for schemes investing predominantly in debt and money market instruments changed from April 2023 and were adjusted again afterwards, so confirm the present treatment in the Income Tax Act or the scheme information document before redeeming.
Frequently Asked Questions
Which is better for parking money for six months?
Six months sits right at the boundary. An ultra short fund matches that horizon almost exactly, while a low duration fund could still be fine if there is no exit load and you can tolerate a slightly larger interim dip.
Is an ultra short duration fund the same as a liquid fund?
No. A liquid fund is defined by instrument maturity within 91 days, while an ultra short fund is defined by Macaulay duration of 3 to 6 months and can hold longer paper. Liquid funds also have a graded exit load structure for redemption within the first week.
Can these funds give negative returns over a month?
Yes, though rarely. A sharp rise in short term yields or a downgrade in a holding can produce a negative month. Over a holding period matching the fund’s duration, the accrual usually more than covers it.
Why does my low duration fund show a two year bond in the portfolio?
Duration is a portfolio level average, so a longer bond can sit alongside very short paper and cash while the overall Macaulay duration stays within 6 to 12 months. What matters is the aggregate figure disclosed in the factsheet.
Are these good alternatives to a recurring deposit?
They serve a similar purpose for short term savings but work differently. A recurring deposit gives you a contracted rate and insured principal within limits, while these funds give market linked returns with daily liquidity and no assured outcome.
Key Takeaways
- SEBI sets ultra short duration at Macaulay duration of 3 to 6 months and low duration at 6 to 12 months.
- Modified duration multiplied by the yield change gives a quick estimate of NAV impact.
- Duration measures rate risk only. Credit risk is a separate and larger danger in these categories.
- Use the rating breakup and the potential risk class matrix before comparing returns.
- Match the category to your date, check exit load, and prefer low cost direct plans.
