What are Short Duration Debt Fund? Definition, Advantages and Taxation

Published On: 27-Oct-2020

Debt funds provide an excellent alternate investment option for investors for traditional investment products. The debt funds may be categorised based on their investment strategies and/or the issuer companies wherein such funds are invested. One such broad category of funds is duration funds, wherein the funds may be classified based on the duration of the debt fund, e.g., short-duration fund, medium duration fund, long-duration fund, etc. 


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This article aims to specifically discuss the short-term investment needs of the investors, viz. short duration funds. 

What is a Short Duration fund?

Short duration fund is a type of debt fund that invests in short duration debt and money market securities. As per the classification norms for mutual fund schemes issued by SEBI, short duration funds must invest in debt & money market instruments such that the Macaulay duration of the portfolio is between one year to three years. Macaulay duration measures the investment portfolio's sensitivity to the interest rate risk, i.e., the risk of changes in the valuation of debt securities due to the interest rate movements in the market. With the investment duration lying between one to three years, the interest rate risk is low to moderate. 

As of 30st Sept 2020, short-duration debt funds are among the most popular debt fund categories with an AUM (Assets Under Management) of Rs. 1.21 lakh crores with 10% share amongst the open-ended debt funds, only after liquid funds and corporate bond funds. Source: Association of Mutual Funds in India – AMFI. 

Advantages of Short Duration Funds

  1. Better Accrual Income - India generally reflects an increasing yield curve, meaning that the interest rates tend to increase as the tenor of the debt instrument increases. With duration of one to three years, the investors may aim to generate relatively better returns through the accrual income from debt securities.

  2. Mitigation of Interest Rate Risk – Interest rate risk is mitigated for the investors due to the mandated lower Macaulay duration for such funds.

  3. Management of Credit Risk - Fund managers manage the credit risk by carefully analysing the financial strength of the issuer entities and regularly monitoring the material events impacting the issuer entities.  

How to Invest in Short Duration Debt Funds?

One may submit the application forms at any of the official Point of Acceptance (POA) for mutual funds or by investing online through the website/ mobile app of the mutual fund house or Registrar & Transfer Agent (R&TA). One may hold the units of short duration funds either in investor folios or in a Demat account and register a Systematic Investment Plan (SIP) to make regular investments in such funds. 

Taxation of Short Duration Funds

Since the portfolio of debt funds will predominantly comprise of debt securities, all debt funds, including short-duration funds, are classified as 'other than equity-oriented funds' for tax purposes. If the investors stay invested for less than 36 months, the gains are classified as Short-Term Capital Gains (STCG). Such gains are added to the taxable income of the investor and taxed at regular tax rates applicable to the investor. 

However, if the units have been held for 36 months or more, the gains may be classified as Long-Term Capital Gains (LTCG) and taxed at 20% (plus applicable surcharge and Cess) with indexation benefit. Indexation allows the invested amount to be adjusted for the prevailing inflation as per the Cost Inflation Index (CII) notified by the government. This reduces the effective tax rate on LTCG on such funds. 

Note: The tax provisions, as mentioned in the article, are for illustrative purposes only, and are updated as per the Finance Act 2020. The tax rates for capital gains will be as per the tax laws applicable on the date of redemption/ sale and not on the date of investment.