Money-market funds and short-duration funds differ in investment horizon and asset mix

Money-market fund vs short-duration fund: Key differences explained (AI-generated image)AI Quick ReadThere are different types of debt mutual funds based on the types of instruments they invest in and the maturity profile of those investments. Two categories that often appear similar to investors are money-market funds and short-duration funds.

Money-market funds primarily invest in short-term instruments maturing within one year, while short-duration funds invest in a mix of debt securities and money-market instruments with a portfolio duration of 1 to 3 years.

Although both belong to the debt fund category, they differ significantly in terms of investment horizon, risk profile, and return potential. Let's find out.

As per Sebi regulations, money-market funds must invest in money-market instruments with a maturity of up to 1 year.

Money-market instruments are short-term debt securities that generally mature within one year. This includes treasury bills, commercial papers, certificates of deposit, call and notice money, commercial bills, and short-term government securities.

These funds are primarily designed for investors looking to park surplus money for short periods, build an emergency corpus, or maintain liquidity while earning potentially better returns than a traditional savings account.

As per SEBI's classification framework, short-duration funds are required to invest in debt and money market instruments and maintain a portfolio's Macaulay duration between 1 and 3 years.

Macaulay duration is a measure that reflects the weighted average time it takes for an investor to recover the invested amount through periodic interest payments and the final repayment of principal.

The underlying instruments include government securities, high-rated corporate bonds (AAA/ AA), PSU bonds, certificates of deposit, commercial papers, and other fixed-income instruments.

The flexibility to invest across various debt segments allows short-duration funds to balance income generation with interest rate risk.

Here are the key differences between money-market and short-duration funds.

Money-market funds invest primarily in short-term instruments such as treasury bills, commercial papers, and certificates of deposit that mature within one year. On the other hand, short-duration funds invest across a wider range of debt securities, including government bonds, corporate bonds, PSU bonds, and money-market instruments.

Money-market funds hold securities with maturities of up to one year, whereas short-duration funds maintain a portfolio Macaulay duration of 1 to 3 years, giving them a longer average maturity profile.

Since money-market funds invest in very short-term securities, they are less sensitive to changes in interest rates. Short-duration funds carry relatively higher interest rate risk because of their longer duration.

Money market funds are designed to provide stability and liquidity, with returns linked to interest rates of short-term instruments. Short-duration funds may offer slightly higher return potential by taking on additional duration risk.