I am a 50-year-old salaried professional from Ahmedabad. I want to park ₹3 lakh, which is a part of my emergency fund, in a debt mutual fund. Considering the fact that we are at bottom of interest rate cycle and rates are expected to go up, I understand it would be better to invest in short-duration funds or low-duration funds. Is my understanding correct? What is the difference between low-duration and short-term debt funds? Can you suggest a couple of such funds for me to invest in?
Shailesh Singh
We do hope you have a bank fixed deposit component in your emergency fund. Bank fixed deposits that can be liquidated online are usually a quick source of emergency cash. Mutual fund redemption proceeds can take a few days to land in your account. However, if you do want to have a mutual fund allocation, then low-duration and short-term debt funds are a reasonable choice.
In a rising rate scenario, it makes sense to invest in funds that focus on bonds with very short tenors, because then you don’t lock into low rates for long and you have the opportunity to explore bonds with better rates when your investments mature. Going by this yardstick, liquid funds should theoretically make for good choices during rising rate scenarios for emergency money because they invest in less than 90-day paper, which will mature quickly. But the flip side of liquid funds is that they stick only to highly liquid, mostly sovereign instruments that are offering very low returns.
Low-duration and short-duration funds not only hold slightly longer maturity instruments, they have leeway to invest in corporate instruments like commercial paper, which offer better returns. Given that you may not actually withdraw your emergency funds for long periods, it would be better not to lock in at very sub-par returns. Under SEBI’s categorisation norms, low-duration funds are supposed to maintain a Macaulay duration of 6-12 months for their portfolios while short-duration funds get leeway to stretch the duration to 1 to 3 years.
IDFC Low Duration Fund and DSP Low Duration Fund are reasonable choices in the low-duration category while Kotak Bond Short Term Fund and HDFC Short Term Debt Fund are good picks in the short-term category.
As the performance of Aditya Birla Sun Life Tax Relief is not satisfactory, I have shifted a few free units of the fund to Aditya Birla Sun Life GenNext fund and Aditya Birla Sun Life Digital India fund through Systematic Withdrawal Plan. Please tell me whether my decision is correct.
MX Thomas
It is true that this fund has not performed well relative to peers over 1 and 3-year time frames. However, when deciding to redeem or switch out of funds, it pays to review why you invested in the fund in the first place. If you invested in Aditya Birla Tax Relief because, by nature of its portfolio and strategy it was a diversified multi-cap fund that helped you invest towards the long term, it wouldn’t make sense to switch out the money into thematic funds as you have done.
Thematic funds such as the GenNext Fund and Digital India Fund are designed to capitalise on opportunities arising from certain sectors or themes that are performing well right now, riding on recent policy developments or market trends. With thematic funds, you need to be able to track the progress of the underlying theme to make good buy and sell decisions. As thematic funds tend to have concentrated holdings in select stocks or sectors, they are riskier than the typical multi-cap fund. Your overall allocation to such funds in your portfolio also needs to be lower than in the case of a multi-cap type diversified equity fund. Multiple switch decisions in a year can increase the costs associated with your mutual fund holdings as you may end up incurring both exit loads and capital gains tax each time you transact.
In future, when in doubt about where to switch the proceeds of an underperforming equity fund, keep index funds tracking the Nifty50, Nifty100 or Sensex30 from the same AMC in mind so that you can invest in a low-cost option where active calls can’t lead to underperformance.
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