Best low-risk mutual funds for short-term
We know that investments in mutual funds are subject to market risks.
But did you know that certain categories and sub-categories of mutual funds carry high risk, while in others, the risk is low?
Specifically, if you want to invest for the short term, then you need to consider low-risk mutual funds.
These mutual funds typically invest in debt & money market instruments, treasury bills, and money market instruments.
The objective is to prioritise capital preservation instead of capital appreciation (which is the case with the high-risk equity mutual funds).
In this editorial, we will explore the top 4 low-risk debt mutual fund subcategories you can consider. These are based on the investment mandate and portfolio characteristics that make these funds low-risk.
#1 Liquid Funds
These funds park your money in low-risk, short-term, money market assets that have a maturity of up to 91 days.
Typically, your money is invested in Treasury bills (T-bills), call money, repurchase agreements, short-term debt securities issued by the government, certificates of deposits (CDs), commercial papers (CPs), and term deposits.
These instruments carry low-interest rate risk and low credit risk. Thus, the priority of a liquidity fund is safety and liquidity over returns. In the entire risk-return spectrum of debt funds, liquid funds carry the least risk (after overnight funds).
Ideally, to keep risk low, you should choose a liquid fund that has minimal exposure to money market instruments such as CDs and CPs.
The investment objective of a liquid fund is to provide you with capital preservation and liquidity, not high returns. The performance is usually benchmarked against the Crisil 1 Year T-Bill Index.
You can expect returns slightly more than what you earn from a savings bank account.
If you have an investment horizon of a few months (3-4 months or so), a liquid fund can be an alternative to keeping money in a savings bank account.
Returns of Liquid Funds
| 6 Months | 1 Year | 2 Years | |
| Category Average | 3.56 | 7.33 | 7.21 |
| Crisil 1 Yr T-Bill Index | 3.78 | 7.63 | 7.31 |
Category average returns of all liquid funds considered. Growth option and Direct Plan are taken into account.
Returns are on a rolling basis and in %. Those depicted over 1-Yr are compounded annualised.
Please note that this table represents past performance. Past performance is not an indicator of future returns.
The securities quoted are for illustration only and are not recommendatory.
Source: ACE MF
Liquid funds, on average, have delivered 3.56% returns over 6 months and 7.33% in a year.
Want to know which are the top liquid funds in India? Read our editorial here.
#2 Ultra Short Duration Funds
These funds are next on the list of low-risk mutual funds. Ultra Short Duration Funds invest in higher-maturity debt papers and money market instruments.
As per the regulatory guidelines, they invest in debt & money market instruments such that the Macaulay duration of the portfolio is between 3 months to 6 months.
In simple words, the Macaulay Duration is the weighted average term-to-maturity of the cash flows of bonds or debt securities held in the portfolio.
The investment objective is to provide investors with an opportunity to generate regular income with a high degree of liquidity through investments in a portfolio comprising debt and money market instruments.
The performance is usually benchmarked against the Crisil 1 Year T-Bill Index.
While following a maturity profile, ultra-short duration funds invest in a range of securities such as T-bills, CDs, CPs, securities lending, and repurchase agreements, and government securities (G-secs), among others.
However, as the duration of the securities is slightly higher than liquid funds, the risk is slightly higher in terms of interest rate risk.
Keep an investment time horizon of around 6-8 months or more when considering ultra-short duration funds.
Returns of Ultra Short Duration Funds
| 6 Months | 1 Year | 2 Years | 3 Years | |
| Category Average | 3.83 | 7.70 | 7.47 | 6.72 |
| Crisil 1 Yr T-Bill Index | 3.78 | 7.63 | 7.31 | 6.39 |
Category average returns of all ultra-short duration funds are considered. Growth option and Direct Plan are taken into account.
Returns are on a rolling basis and in %. Those depicted over 1-Yr are compounded annualised.
Please note that this table represents past performance. Past performance is not an indicator of future returns.
The securities quoted are for illustration only and are not recommendatory.
Source: ACE MF
These funds have, on average, delivered 3.83% returns over 6 months and 7.7% in a year. These returns are slightly better than liquid funds and a bank fixed deposit (FD).
#3 Banking & PSU Debt Funds
These funds are mandated to invest a minimum of 80% of their assets in top-rated corporate debt instruments issued by Banks, PSUs, and PFIs.
Instruments issued by Banks, PSUs, and PFIs carry higher credibility and liquidity compared to private issuers and are therefore relatively safer.
They aim to generate income by investing in these securities while maintaining the optimum balance of yield, safety, and liquidity.
When investing in the mentioned instruments, banking & PSU debt funds have the flexibility to diversify their exposure across the yield curve.
This means there could be a mix of short-term, medium-term, and long-term debt securities held in the portfolio.
The fund manager evaluates the interest rate cycle and a host of micro and macroeconomic factors to determine a suitable duration strategy.
Most banking & PSU debt funds maintain a duration of 2 to 5 years. This makes these funds more sensitive to interest rate risk.
Nevertheless, they may potentially benefit from regular coupon payments and may employ a partial accrual strategy to mitigate volatility during rising interest rate periods.
Therefore, the potential to earn returns is a bit higher if the fund follows a prudent strategy.
Much depends on the portfolio characteristics of the fund. The performance is usually benchmarked against the Crisil 10 Year Gilt Index.
You need to keep an investment horizon of around 2-3 years and be ready to assume slightly more risk in these funds.
Returns of Banking & PSU Debt Funds
| 6 Months | 1 Year | 2 Years | 3 Years | |
| Category Average | 4.43 | 8.66 | 7.84 | 6.77 |
| Crisil 10 Yr Gilt Index | 5.28 | 10.35 | 8.91 | 7.04 |
Category average returns of all banking & PSU debt funds considered. Growth option and Direct Plan are considered.
Returns are on a rolling basis and in %. Those depicted over 1-Yr are compounded annualised.
Please note that this table represents past performance. Past performance is not an indicator of future returns.
The securities quoted are for illustration only and are not recommendatory.
Source: ACE MF
Banking & PSU debt funds, on average, over 1 year, have clocked 8.66% absolute returns.
Over 2 and 3 years, these funds have delivered 7.84% and 6.77% compounded annualised rolling returns, respectively, as of 11 August 2025.
Some schemes have managed to outperform the category average and benchmark. Hence selection of the right fund matters.
#4 Corporate Bond Funds
These funds, as per the regulatory guidelines, are required to invest at least 80% of their assets only in the highest-rated corporate bonds, i.e., AA+ and above.
The objective is to generate income by maintaining an optimum balance of yield, safety, and liquidity.
As regards duration, these funds have the liberty to invest across maturities. That being said, the average maturity profile of most corporate bond funds is between 1 to 3 years. This makes them less sensitive to interest rates than banking & PSU debt funds.
It can be said that corporate bond funds are moderately sensitive to interest rates, and the credit risk of the portfolio is low. Their performance is usually benchmarked against the Crisil 10 Year Gilt Index.
If you have an investment horizon of around 2 to 3 years, these funds can be considered. In a falling interest rate scenario, these funds could yield decent returns due to the inverse relationship between bond yields and prices.
Returns of Corporate Bond Funds
| 6 Months | 1 Year | 2 Years | 3 Years | |
| Category Average | 4.60 | 8.91 | 8.04 | 6.86 |
| Crisil 10 Yr Gilt Index | 5.28 | 10.35 | 8.91 | 7.04 |
Category average returns of all corporate bond funds considered. Growth option and Direct Plan are taken into account.
Returns are on a rolling basis and in %. Those depicted over 1-Yr are compounded annualised.
Please note that this table represents past performance. Past performance is not an indicator of future returns.
The securities quoted are for illustration only and are not recommendatory.
Source: ACE MF
Corporate bond funds over 2 years and 3 years have clocked compounded annualised rolling returns of 8.04% and 6.86%, respectively, as of 11 August 2025. Some schemes have managed to outperform, which makes scheme selection crucial.
Conclusion
Thoughtfully choose mutual funds, considering your personal risk profile, investment objective and time horizon.
Keep in mind that although debt funds are less risky than equity mutual funds, they are not 100% safe. There is a certain element of risk involved, depending on the scheme you are investing in.
Hence, other than historical returns, also consider the following:
- The credit quality of the underlying securities
- The performance across interest rate cycles
- The average maturity profile
- The risk ratios of the fund (Standard Deviation, Sharpe Ratio, Sortino Ratio, etc.)
- The credentials and experience of the fund management team
- The investment processes & systems at the fund house
Invest sensibly.
Happy investing.
Disclaimer
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