Ultra short-term funds and liquid funds have had a good rally over the last one year, delivering a return of 9 per cent. With almost no risk of capital loss, this return can be called top-notch.

These funds, which typically invest in maturities of around three months, benefitted from the rising interest rates. In fact, the above performance is the best delivered by this category of funds since 2009. The reason for the strong performance by liquid funds was tight liquidity in the system, leading to higher demand for short-term money. The annualised yields on three-month certificates of deposits went to a three-and-a-half-year high of 11.5 per cent in March.

The category average of ultra-short term funds was marginally higher than liquid funds, given the former's slightly longer maturity horizon. As the focus of the latter is to provide liquidity, they tend to have lower portfolio maturity (which comes with relatively lower rates). They also invest a majority of their portfolio in securities with top investment ratings.

Top performers

Of the 99 liquid and ultra short-term funds with a one-year record or more, 76 per cent of the funds managed to beat the CRISIL Liquid Fund index return of 8.6 per cent. Sahara Short Term Bond Fund, Escorts Liquid Fund, JM Money Manager Fund and Baroda Pioneer Treasury Advantage Fund are the top performing funds. These funds returned anywhere between 9.8 and 14.4 per cent to investors.

Funds such as Escorts Liquid and JM Money Manager generated higher returns by holding more commercial papers. Commercial papers have higher risks than certificates of deposits. On the other hand, DWS Money Plus, Templeton India Cash Management Account, Mirae Asset Liquid and HSBC Ultra Short Term Bond were the laggards. That said, all the funds in the universe managed return of more than 7 per cent.

In the case of funds such as Bharti Axa Liquid Fund and Mirae Cash Management Fund, reliance on CBLO (collateralised borrowing and lending obligations) overnight market was the reason for low returns. CBLO rates are lower than the commercial paper rates. But their risk is lower as overnight market instruments have almost no duration (interest) risk.

Leaving out the outliers, 85 per cent of the funds generated returns that ranged between 8 and 10 per cent.

Outlook

With liquidity deficit persisting even after the interest rate cut, the rates on money-market instruments remain above 9 per cent. After September, when demand for credit typically picks up short-term rates may rise further. Liquid funds may, therefore, well continue with their current performance.

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