Short duration fund
Also written Short Term Fund
An open-ended debt scheme in the short end of the curve: Chapter 2 defines the "Short Term Fund" by a Macaulay duration of 1 to 3 years; Chapter 12 describes maturities of 1 to 3 years.
In plain language
A short duration fund is a debt fund that stays in bonds that do not take long to come back.
Because its bonds mature relatively soon, its NAV does not swing much when interest rates change. And when rates rise, the fund soon gets its money back from maturing bonds and can reinvest at the new, higher rates.
That makes it, in the workbook's words, a low-volatility fund suitable for the core portfolio of an investor with low risk-taking ability, and for parking money for the short term. It earns more than a liquid fund, with somewhat more rate risk.
How it works
Two descriptions in the workbook:
- Chapter 2 (SEBI categorisation, 2026): "Short Term Fund: An open-ended short-term debt scheme investing in debt and money market instruments with Macaulay duration of the portfolio between 1 year and 3 years."
- Chapter 12 (Scheme Selection): "Short Duration Funds invest in securities with maturities between 1 year and 3 years."
The two differ in name (Short Term Fund versus Short Duration Fund) and in measure (portfolio Macaulay duration versus security maturity). For a coupon-paying bond, Macaulay duration is shorter than maturity, so the two tests are not identical. For a category question, use Chapter 2's SEBI definition; for a suitability question, Chapter 12's description is what the workbook uses.
Neighbouring categories (Chapter 2), by Macaulay duration of the portfolio:
| Category | Portfolio Macaulay duration |
|---|---|
| Ultra-Short-Term Fund | 3 to 6 months |
| Ultra Short to Short Term Fund | 6 to 12 months |
| Short Term Fund | 1 to 3 years |
| Medium Term Fund | 3 to 4 years |
| Medium to Long Term Fund | 4 to 7 years |
| Long Term Fund | Greater than 7 years |
Selection view (Chapter 12): returns are in line with market yields; some funds take small exposure to longer securities to gain if rates are expected to fall; if rates are expected to rise, it is safer to increase allocation to short duration funds, as maturing bonds are reinvested at higher rates. Low volatility; suitable for the core of a low-risk portfolio and for short-term parking. On the interest rate risk ladder (Illustration 12.1.2), risk and potential return rise from overnight and liquid funds through ultra short and low duration to short duration and beyond.
A worked example
Durations and rate moves are illustrative; the approximation below uses the rule that price change ≈ −duration × yield change.
An investor holds Rs 5,00,000 in each of two debt funds when yields rise by 1 percentage point in a year.
| Short duration fund | Long term fund | |
|---|---|---|
| Portfolio duration (approx.) | 2 years | 8 years |
| Price impact of +1% yields | about −2% → −Rs 10,000 | about −8% → −Rs 40,000 |
Suppose both portfolios earn about 7% in interest over the year (Rs 35,000):
Short duration: 35,000 − 10,000 = +Rs 25,000 (about +5%)
Long term: 35,000 − 40,000 = −Rs 5,000 (about −1%)
And the short duration fund's bonds keep maturing during the year, so the manager reinvests at the higher yields, which is the advantage Chapter 12 describes when rates are expected to rise.
The position reverses if yields fall: the long term fund gains far more. That is why the workbook links short duration funds to an expectation of rising rates.
Why NISM asks about it
Chapter 2 (Concept and Role of a Mutual Fund) defines the SEBI debt categories by Macaulay duration, including the Short Term Fund; Chapter 12 (Mutual Fund Scheme Selection) describes short duration funds, their behaviour when rates rise and their place in a portfolio. Expect a duration band question, a question on what to do when rates are expected to rise, and which category suits short-term parking with low volatility.
Common exam traps
- Chapter 2: Macaulay duration 1 to 3 years, named Short Term Fund. Chapter 12: maturities 1 to 3 years, named Short Duration Fund. Know both.
- Rates expected to rise → increase short duration allocation. Rates expected to fall → longer duration gains more.
- Ultra-Short-Term: 3 to 6 months; Ultra Short to Short Term: 6 to 12 months in the 2026 categorisation.
- Not a liquid fund. Liquid funds hold instruments up to 91 days; the workbook says liquid schemes suit parking for very short periods.
- Low volatility is not zero volatility; rate rises still reduce NAV in the short run.
- Duration, not credit, is the defining feature of this category.
Check yourself
1.Assuming credit risk is broadly similar, which of the following debt fund categories carries the highest interest rate risk?
- a)Medium duration fund
- b)Short duration fund
- c)Low duration fund
- d)Ultra short duration fund
Show the answer
Answer: (a) Medium duration fund
Illustration 12.1.2 sets out the risk-return hierarchy of debt funds: "Overnight funds – Liquid funds – Ultra short duration funds – Low duration funds – Short duration funds – Medium duration funds – Medium to long duration funds – Long duration funds." The workbook explains that "as we move from left to right, the potential returns as well as the INTEREST RATE RISK increases. The assumption here is that the credit risk is more or less similar in each of the categories." Of the four options, the medium duration fund sits furthest to the right.
- Short duration — one step to the left of medium duration, so less interest rate risk.
- Low duration — further left again.
- Ultra short duration — the lowest of the four, just after overnight and liquid funds.
Credit risk is ranked separately (Illustration 12.1.3): Gilt – Banking and PSU – Corporate bond – Credit risk fund, with interest rate risk assumed similar. The workbook says a scheme should be compared on one risk while the other is held constant.
2.Which statement about liquid funds and ultra-short term debt funds is correct as per the workbook?
- a)The comparable for a liquid fund, for a retail investor, is a fixed deposit of one to three years
- b)Ultra-short term debt funds hold securities with tenors of one to three years
- c)Liquid funds are best suited to long-term core investment because they have negligible volatility
- d)Liquid funds suit parking money for very short periods of up to 91 days, and their comparable for a retail investor is a savings bank account; ultra-short term debt funds hold securities of 3 to 6 months and play a similar role
Show the answer
Answer: (d) Liquid funds suit parking money for very short periods of up to 91 days, and their comparable for a retail investor is a savings bank account; ultra-short term debt funds hold securities of 3 to 6 months and play a similar role
The workbook: "An investor seeking the LOWEST RISK ought to go for a liquid scheme. However, the returns in such instruments are low. The COMPARABLE for a liquid scheme in the case of retail investors is a SAVINGS BANK ACCOUNT. These schemes are suitable for investors looking for a product to park their funds for very short periods (UP TO 91 DAYS)... ULTRA-SHORT TERM debt funds hold securities with slightly longer tenor than liquid funds, 3 TO 6 MONTHS, but play a similar role."
- A 1–3 year fixed deposit — the workbook's comparable is the savings bank account. The 1–3 year range belongs to short duration funds.
- Ultra-short holding 1–3 years — ultra-short term funds hold 3 to 6 months. One to three years is the short duration category.
- Long-term core holding — "Using these schemes for longer periods is NOT ADVISED since the investor will be needlessly losing out on returns."
3.A debt investor expects interest rates in the market to rise. According to the workbook, which move is safer?
- a)Shift to long duration funds to lock in the current yields
- b)Increase allocation to long-term gilt funds, since they carry no credit risk
- c)Increase allocation to short duration funds, since their bonds mature and the proceeds can be reinvested at the higher rates
- d)Move to a dynamic bond fund whose manager is lengthening the portfolio's maturity
Show the answer
Answer: (c) Increase allocation to short duration funds, since their bonds mature and the proceeds can be reinvested at the higher rates
The workbook: "Short Duration Funds invest in securities with maturities between 1 YEAR AND 3 YEARS... If it is expected that interest rates in the market would INCREASE it is SAFER TO INCREASE ALLOCATION TO SHORT DURATION FUNDS. As the rates rise, the short-term bonds would mature, allowing the fund manager to deploy the proceeds at higher rates." These funds "feature low volatility and can form part of the core portfolio of an investor with low risk-taking ability."
- Long duration funds — longer maturities carry the most interest rate risk. When rates rise, their prices fall the most.
- Long-term gilt funds — having no credit risk does not remove interest rate risk. The workbook recommends long-term gilt funds when an investor has "a view that interest rates will DECLINE", which is the opposite view.
- A dynamic bond fund lengthening maturity — lengthening maturity is what a manager does when rates are expected to fall. When they are expected to rise, a manager would shorten it.
Where this is taught
Free preparation for NISM Series V-DRelated terms
- Modified DurationMacaulay's duration divided by (1 + yield) — the percentage by which a bond's price moves for a one percentage point change in interest rates, and so the standard measure of interest rate risk.
- Credit spreadThe extra yield a non-government borrower must pay over a government security of the same tenor — the market price of credit risk, quoted as an add-on over the risk-free rate.
- Macaulay durationThe weighted average time, in years, to receive a bond's cash flows, each weighted by the present value of that cash flow — the bond's effective payback period.
- Clean priceThe quoted price of a coupon bond, excluding interest accrued since the last coupon date. Bonds trade at the clean price and settle at the dirty price, which adds accrued interest.
- Macaulay duration bucketThe duration band an index provider uses to sort bonds — NIFTY bond indices run six such buckets, from Ultra-Short at 3 to 6 months up to Long Duration above 7 years.