ShortTerm Funds

Sometimes we may not need instant access to our money.At the same time we may not want tolock in funds in a fixed deposit as we might require it in the near future.

Short Term Funds are designed to optimize returns for such short duration (6 monthsto 1 year).

What are Short Term Funds?

Short term funds are the debt mutual fund schemes that seek to generate regular income by investing in short term debt securities and money market instruments. The portfolio is comprised of instruments like Certificates of Deposits (CDs), Commercial Paper (CP), corporate debt, treasury bills, central or state government securities. The average maturities of short term funds range between 1 to 3 years.

Short term funds are positioned between ultra short term funds and income funds in terms of risk-return matrix.

Features of Short Term Funds

• Risk-Return trade off: A short term fund delivers Total Return. This is a combination of the return from interest earned (called interestaccrual), and that from change in the market value of securities (called mark-to-market or MTM). Short term funds have moderateMTM and interest rate risk.

          Total Return = Interest Accrual + Capital Gain (Loss)

          Scenario 1: Drop in interest rate.Short term funds benefitfrom the high accrual when short term rates             are high due to liquidity crunch in the market. Asthe interest rates begin to drop, they benefit from                 capital gain on the portfolio.

          Scenario 2: Rise in interest rate.Increase in short term rates can result in MTM losses on the portfolio.           However, a relatively lower duration of short term funds reduces volatility in returns. Low duration                also helps in taking advantage of rising rates by re-investing at higher yields.

• Liquidity: Being an open ended scheme, units in shortterm funds can be sold at any time without regard to bond maturities subject to exit load as applicable for the scheme.
• Taxation: As per tax rates applicable for Individual/HUF for FY2013-14, applicable from Jun 1, 2013.Dividend Distribution Tax (DDT): Dividends are tax free in the hands of investors. However, fund houses need to pay dividend distribution tax of 28.325% (25%+10% surcharge+3% Cess) at source.Short Term Capital Gain (STCG): Investment for a period of upto12 months qualify for short-term capital gains. STCG is taxed at marginal rate of taxation.Long Term CapitalGain (LTCG): Investment for a period of more than 12 months qualify for long-term capital gains. LTCGis 10% without indexation or 20% with indexation whichever is lower, Plus 10% surcharge plus 3% cess.

Outlook

Interest rates at the short end currently are at 10.51% and 11.45% for 1 year CD and CP respectively . The elevated short term rates providetwo advantages:

a. Locking in current yields will ensure a reasonably good accrual

b. The fall in the short term yields would be steep, than that of the long term yields when the yield curve turns flattish from inverted. This will ensure capital gainson the portfolio. However, the flattening of the Yield Curve would be gradual .

Who should invest?

Short Term Funds are ideal for investors having conservative / Moderate risk profile and investment horizon of 6 months to a year.