Ultra Short Term Fund: How SEBI’s 3-6 Month Duration Rule Works

An ultra short term fund is the debt fund you reach for when a liquid fund feels too tame and a short term fund feels like too much rate risk. SEBI pins it down with a single number: the portfolio’s Macaulay duration has to sit between three and six months. That one band decides how the fund earns, how much it can wobble and where it fits in your money plan.

We’ll walk through what the rule says, work out a portfolio’s duration by hand, look at the liquidity and swing-pricing rules that sit on top, and end with a checklist you can run on any scheme in this category.

What SEBI means by an ultra short term fund

SEBI’s Master Circular for Mutual Funds dated March 20, 2026 lists 17 categories of debt schemes. Ultra Short Term Fund is category number 3. The scheme characteristic reads simply: investment in debt and money market instruments such that the Macaulay duration of the portfolio is between 3 months and 6 months.

The uniform description every fund house must use is “an open ended ultra-short term debt scheme investing in instruments such that the Macaulay duration of the portfolio is between 3 months to 6 months”. If a scheme calls itself an ultra short term fund, that’s the promise it is making.

Two details are easy to miss. First, the rule is about the portfolio’s duration, not the maturity of each paper. A fund can hold a bond that matures in a year as long as the weighted average still lands inside the band. Second, the circular says Macaulay duration is to be mentioned at the portfolio level and that the concept has to be explained in the Scheme Information Document. So the number you should be tracking is printed in the fund’s own factsheet and SID, not something you have to guess.

You’ll also see the older label “ultra short duration fund” in places. The same March 2026 circular still uses that phrase in a few sections, such as its benchmark example and performance-disclosure rules, while the category table itself says Ultra Short Term Fund. Treat them as the same bucket when you read old factsheets.

Where it sits among the short-end debt categories

The short end of SEBI’s debt list is crowded, and the categories differ mainly in how far out they are allowed to go. Every row below comes from the same SEBI table.

Look at the second column. Overnight, liquid and money market funds are boxed in by the maturity of what they buy. The ultra short term fund is boxed in by duration. That gives the manager a little more room: some paper can run longer than six months as long as shorter holdings pull the average back down.

It also means the ultra short term fund sits one notch above a liquid fund on rate risk and one notch below the ultra short to short term fund. If you have read our pieces on the overnight fund and the money market fund, this is the next rung up the same ladder.

Macaulay duration in plain words

Macaulay duration is the weighted average time, in years, it takes to get your money back from a bond, counting every coupon and the final repayment, with each cash flow weighted by its present value. For a zero-coupon instrument such as a commercial paper or a certificate of deposit, which pays one lump sum at maturity, the Macaulay duration is simply its time to maturity.

Most of what an ultra short term fund owns at this end of the curve behaves close to that zero-coupon case. So for a quick sense check, you can treat each holding’s duration as roughly its remaining maturity and take a weighted average. Our longer explainer on bond duration covers coupon bonds and the full formula.

The rule caps the average, not each bond. That small gap is where most of the differences between two ultra short term funds come from.

Worked example: does this portfolio qualify?

Take a made-up portfolio. The weights and maturities below are illustrative, chosen only to show the arithmetic, and are not taken from any real scheme.

The portfolio’s Macaulay duration is 0.475 years. Multiply by 12 and you get 5.7 months. That’s inside the 3-to-6-month band, but only just.

Now say the manager likes the yield on one-year paper and moves another 10% out of the 3-month commercial paper into it. The 3-month bucket drops to 20% and the 1-year bucket rises to 30%. The new figure is 0.05 + 0.20 + 0.30 = 0.55 years, or 6.6 months. The fund has drifted out of its category. To pull it back, the manager has to sell some longer paper or add shorter paper.

Two practical lessons fall out of this. A fund running near 5.5 to 6 months has less room to chase yield than one sitting at 4 months. And the overnight slice matters more than it looks, because its near-zero duration drags the average down.

The 10% liquid buffer and why it helps the duration maths

Section 5.7 of the master circular says all open ended debt schemes, except overnight funds, liquid funds, gilt funds and 10-year constant maturity gilt funds, must hold at least 10% of net assets in liquid assets. Ultra short term funds are not on the exempt list, so the rule applies to them.

The circular also spells out how that buffer is counted. For asset-allocation limits in four specific categories (banking and PSU debt, floating rate, credit risk and corporate bond funds), the base is net assets minus the 10% buffer. For every other regulatory calculation, and Macaulay duration is named explicitly, the base is 100% of net assets.

In our example, that’s why the 10% sitting in T-bills and TREPS counts toward the 0.475-year average. The buffer is part of the portfolio when SEBI measures duration. If the fund dips below the 10% liquid floor, the circular says the AMC must restore it before making further investments.

Rate risk: what a move in yields does to the NAV

Duration is useful because it translates directly into price sensitivity. As a rough rule, a portfolio’s NAV moves by about its duration multiplied by the change in yields, in the opposite direction. (Strictly that’s modified duration, which is a touch smaller than Macaulay duration, but the gap is tiny at this end of the curve.)

Run it on our 0.475-year portfolio. If yields across its holdings rise by 0.50 percentage points overnight, the mark-to-market hit is roughly 0.475 x 0.50% = about 0.24% of NAV. Compare that with a short term fund at the bottom of its 1-to-3-year band: the same 0.50 point rise costs about 0.50% at a 1-year duration and about 1.5% at 3 years.

The other side is accrual. Suppose the portfolio’s yield is 7% a year, a round number picked for the example, not a current market rate. That works out to roughly 0.58% a month. A 0.24% knock gets earned back in well under a month of accrual. That’s the whole appeal of the category: small rate shocks are absorbed quickly, so a holding period of a few months is usually enough to ride them out.

Credit is the risk duration doesn’t capture. Unlike corporate bond funds, the ultra short term category has no minimum rating rule in SEBI’s table. Two funds with the same 5-month duration can carry very different credit risk, so the rating mix in the factsheet deserves as much attention as the duration line.

Swing pricing and what it means for redemptions

Section 5.8 of the circular applies a swing pricing framework to open ended debt schemes, except overnight funds, gilt funds and 10-year gilt funds, and only for net outflow scenarios. Ultra short term funds fall inside it. In normal times, AMCs decide whether to swing the NAV within parameters set by AMFI.

During a market dislocation declared by SEBI, swing pricing becomes mandatory for debt schemes rated High or Very High on the risk-o-meter that sit in certain cells of the Potential Risk Class matrix. For schemes with a Macaulay duration of up to one year (interest-rate Class I), the only mandatory cell is C-I, meaning the lowest credit-quality class, where the minimum swing factor is 1.5%. For Class I schemes in the A and B credit classes, the swing is optional.

Here’s how that would look on an illustrative NAV of Rs 1,000. A 1.5% swing factor would mean exiting investors get about Rs 985. The circular says both incoming and outgoing investors get the swung NAV when it’s triggered, that redemptions up to Rs 2 lakh per scheme at the PAN level are exempt, and that scheme performance is calculated on the unswung NAV.

For a small investor redeeming under Rs 2 lakh, swing pricing never touches the NAV they get. It’s a tool aimed at large, sudden exits.

Other rules that apply to this category

• No InvITs. The circular lets debt schemes put their residual portion into InvITs, but it excludes overnight, liquid, ultra short term, ultra short to short term and money market funds.
• Short-period returns. Funds in this short-end group must disclose returns over 7 days, 15 days, 1 month, 3 months and 6 months, in addition to the usual 1, 3, 5 and 10-year and since-inception CAGR against the benchmark. They also don’t get the exemption from performance disclosure that most schemes under a year old have.
• Benchmarks. The circular’s own example of a first-tier benchmark for this category is the NIFTY Ultra Short Duration Debt Index or the CRISIL Ultra Short Term Debt Index.

A checklist before you pick an ultra short term fund

1. Read the current Macaulay duration. Is it near 3 months or pressed up against 6? A fund running at the top of the band has used up its room.
2. Check the rating mix. SEBI sets no credit floor for this category, so look at how much sits in AAA, A1+ and sovereign paper versus lower-rated names.
3. Look at the PRC cell. A Class I scheme in credit class A or B can’t be forced into the mandatory swing; a C-I scheme can.
4. Compare against the benchmark, not last month’s top performer. At this end of the curve, small differences in yield often come from taking more credit risk.
5. Match the holding period. The category suits money you’ll need in roughly three months to a year. For days or weeks, a liquid or overnight fund is the cleaner fit.

None of this makes the category risk-free. The NAV can fall, there’s no guaranteed return, and a credit event in one holding can hurt more than any rate move. Sizing each bucket of your money sensibly matters as much as the fund you pick; our guide to risk management covers that side.

Quick recap

An ultra short term fund must keep its portfolio Macaulay duration between 3 and 6 months, as SEBI’s March 2026 master circular sets out. It has to hold at least 10% in liquid assets, and that buffer counts when duration is measured. Swing pricing can apply on net outflows, with redemptions up to Rs 2 lakh exempt. Read the duration first, the rating mix second and the yield last.

Disclaimer: This article is for information and education only and is not investment advice. Please do your own research or consult a SEBI-registered adviser before making any investment decision.