How are liquid funds different from ultra-short-term funds?

This is an often-asked question as people are usually confused between liquid funds and ultra-short-term funds as an alternative to their savings bank accounts.

Both these funds- liquid funds and ultra-short-term funds- are types of debt mutual funds which invest in short-term market instruments such as government securities, commercial papers, treasury bills, as well as corporate bonds.

Liquid funds

These funds invest in securities with a maturity of up to 91 days. As liquid funds don’t have a lock-in period, it is similar to having cash in your hand or in a savings account. Liquid funds usually give returns in 7-9% range.

Liquid funds are the lowest risk category of debt funds. This is on the back of two main reasons:

- They don’t invest in lower-rated corporate bonds

- They don’t take long-term rate calls.

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Ultra-short-term fund

Ultra-short-term funds invest in securities that mature within seven days to about 540 days (18 months). This fund is one of the best options for investors who want to invest their money over a period of one to nine months. The market regulator– SEBI - has classified ultra-short-term funds as instruments that need to mark-to-market; this means that the price of these securities may change on a day-to-day basis.

Hence, ultra-short-term funds are more fickle than liquid funds, especially in a term of up to 90 days. However, as it invests in a mix of debt and equity, it is less volatile than pure equity schemes. These funds can be different from one another as there isn't any regulatory definition of ultra-short-term funds.

It should also be noted, that unlike liquid funds, ultra-short-term funds may invest in lower-rated corporate debt. These funds may also levy an exit load for investors who redeem units within a specified period.

You can intelligently use ultra-short-term funds for Systematic Transfer Plan. Here, you can instruct the fund house to transfer a regular sum every month from ultra-short-term funds into equity, thereby earning more returns.