Debt Funds — Overnight, Liquid, Ultra-Short, Low Duration
Definition
Under SEBI categorization, short-duration debt fund categories include: Overnight Fund (invests in securities maturing in 1 day), Liquid Fund (invests in securities with maturity up to 91 days), Ultra Short Duration Fund (Macaulay duration of 3-6 months), Low Duration Fund (Macaulay duration of 6-12 months), Short Duration Fund (Macaulay duration of 1-3 years), and Money Market Fund (invests in money market instruments with maturity up to 1 year including T-bills, Commercial Papers, and Certificates of Deposit). These categories are arranged from lowest to highest interest rate risk.
In Simple Words
Industry experience shows that more money has been lost by investors who did not understand debt fund categories than by those who picked the wrong equity fund. A clear framework for understanding these categories is essential. Think of debt funds like a ladder — each rung represents a different maturity bucket, and as one climbs higher, interest rate risk increases but so does the potential return. The bottom rung is the Overnight Fund — it buys securities that mature the very next day. Treasury bills expiring tomorrow, overnight CBLO (Collateralized Borrowing and Lending Obligation), reverse repos. The credit risk is virtually zero and the interest rate risk is zero because the portfolio matures and is reinvested every single day. Returns are modest (3-4%) but the capital is as safe as it can get. Think of it as a savings account alternative. One rung up is the Liquid Fund — the workhorse of corporate and distributor treasury management. It invests in securities with maximum 91-day maturity. No security in the portfolio can mature beyond 91 days. Since 2019, SEBI mandated that liquid funds must also mark-to-market a portion of their holdings, which slightly increased volatility but improved transparency. The standout feature is instant redemption — investors can redeem up to ₹50,000 instantly (credited within 30 minutes on business days). This is why liquid funds are the go-to recommendation for emergency funds and short-term parking. Then come Ultra Short Duration (Macaulay duration 3-6 months), Low Duration (6-12 months), and Short Duration (1-3 years). An important nuance often overlooked is that Macaulay duration is not the same as maturity. Duration measures interest rate sensitivity — how much the NAV will change for a 1% change in interest rates. A fund with 6-month duration will see its NAV drop approximately 0.5% if interest rates rise by 1%. A 3-year duration fund will drop approximately 3%. This is why matching the investor's investment horizon to the fund's duration is critical. The Money Market Fund invests exclusively in money market instruments — T-bills, Commercial Papers (CPs), Certificates of Deposit (CDs) — with maturity up to 1 year. It sits between Liquid and Ultra Short Duration in terms of risk-return.
Real-Life Scenario
Consider the case of Sunita, a small business owner in Ahmedabad, who had ₹25 lakh that she would need across different time frames. A financial advisor structured her allocations as follows: ₹5 lakh needed next week (for a vendor payment): Placed in an Overnight Fund. The return is tiny for a few days, but the money is available the next business day with virtually zero risk. ₹8 lakh needed in 45 days (for a raw material purchase): Allocated to a Liquid Fund. With a 45-day horizon, a liquid fund is ideal — max 91-day maturity securities, instant redemption available. Historically delivering 4-5% annualized, it beats a savings account comfortably. ₹7 lakh needed in 6 months (for equipment down payment): Placed in an Ultra Short Duration Fund. With Macaulay duration of 3-6 months, it aligns with her horizon. Expected return: 5-6% annualized. ₹5 lakh needed in 1.5 years (for a shop renovation): Allocated to a Short Duration Fund (Macaulay duration 1-3 years). This gives the fund manager room to earn slightly higher yields from 1-3 year corporate bonds. Expected return: 6-7% annualized. Six months later, the RBI hiked rates by 0.50%. Here is what happened: - Overnight Fund: No impact (portfolio matures daily) - Liquid Fund: Minimal impact (max 91-day securities) - Ultra Short Duration: NAV dipped 0.2% temporarily, recovered in 2 weeks - Short Duration: NAV dipped 0.8%, recovered in 6 weeks The lesson was clear — the longer the duration, the more sensitive to interest rate changes. But since each fund's duration was matched to the investment timeline, no allocation was caught off guard.
Key Points to Remember
Formula
Approximate Price Change = -Duration x Change in Yield Example: If a fund has Macaulay duration of 2 years and interest rates rise by 1%: Price change ≈ -2 x 1% = -2% (NAV drops by approximately 2%) If rates fall by 0.5%: Price change ≈ -2 x (-0.5%) = +1% (NAV rises by approximately 1%) Note: This is a simplified approximation. Actual impact depends on convexity, yield curve shape, and credit spread changes.
Numerical Example
Arun has ₹10,00,000 in a Short Duration Fund with Macaulay duration of 2.5 years. Scenario 1 — RBI hikes repo rate by 0.50%: Approximate NAV impact = -2.5 x 0.50% = -1.25% Temporary paper loss = ₹10,00,000 x 1.25% = ₹12,500 But if Arun holds for 2+ years, the higher reinvestment yield will compensate Scenario 2 — RBI cuts repo rate by 0.75%: Approximate NAV impact = -2.5 x (-0.75%) = +1.875% Immediate paper gain = ₹10,00,000 x 1.875% = ₹18,750 Plus regular accrual income from coupon payments Compare with Overnight Fund (duration ≈ 0.003 years): Same rate hike of 0.50%: NAV impact = -0.003 x 0.50% ≈ -0.0015% (₹15 on ₹10 lakh) Virtually no impact — that is the beauty of overnight funds for ultra-short parking
Frequently Asked Questions
Test Your Knowledge
4 questions to check your understanding
An Overnight Fund invests in securities with a maturity of:
Summary Notes
Debt fund ladder (low to high interest rate risk): Overnight (1 day) → Liquid (91 days) → Ultra Short (3-6M) → Low Duration (6-12M) → Short Duration (1-3Y) → Money Market (up to 1Y)
Macaulay duration = interest rate sensitivity — match the investor's horizon to fund duration for optimal results
Liquid funds offer instant redemption up to ₹50,000 — the best option for emergency fund parking
Overnight funds are the safest debt fund category — use for 1-7 day parking of surplus cash
For NISM: memorize the Macaulay duration ranges for each category — this is a heavily tested area
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What you’ll learn in Types of Mutual Fund Schemes
Master the complete SEBI categorization of mutual fund schemes — equity, debt, hybrid, and passive funds. Understand the current 36-category framework and the upcoming 40-category expansion effective April 2026. Essential for recommending the right fund to every client.
Frequently asked questions
Why did SEBI limit schemes to 36 categories?
Before 2017, AMCs launched schemes with fancy names that made it nearly impossible for investors to compare funds. Two "large-cap" funds from the same AMC could have completely different mandates. SEBI's 36-category framework ensures clear definitions, prevents scheme proliferation, and allows investors to make genuine comparisons across AMCs. For distributors, this is a significant advantage — it enables confident communication to clients about what a fund will and will not do. Note: From April 2026, the framework expands to 40 categories under the new SEBI (Mutual Funds) Regulations.
Can an AMC launch two Large Cap funds?
No. Under SEBI categorization, each AMC can offer only one scheme per category. The exceptions are Index Funds, ETFs, and Fund of Funds where multiple schemes tracking different indices are permitted. So an AMC can have one Nifty 50 Index Fund and one Nifty Next 50 Index Fund, but only one actively managed Large Cap fund.
What happened to existing schemes that did not fit the 36 categories?
AMCs were given time to either merge non-conforming schemes into the defined categories or wind them up. This led to a massive wave of scheme mergers in 2018-2019. For example, an AMC that had three separate large-cap-style funds had to merge them into one. Investors were given exit options without exit load during the merger period.
What is the AMFI market cap list and how often is it updated?
AMFI (Association of Mutual Funds in India) publishes a list classifying all listed stocks into Large Cap (top 100 by full market capitalization), Mid Cap (101st to 250th), and Small Cap (251st and below). This list is updated semi-annually based on average market capitalization data. All AMCs must follow this list for determining compliance with category-wise allocation norms.
Does the 36-category rule apply to passive funds and ETFs?
Index Funds, ETFs, and Fund of Funds are exceptions to the one-scheme-per-category rule. An AMC can offer multiple Index Funds tracking different indices (Nifty 50, Nifty Next 50, Nifty Midcap 150, etc.) and multiple ETFs. However, each actively managed category is still limited to one scheme per AMC.
What is the difference between Flexi Cap and Multi Cap?
This is the most commonly confused topic. Flexi Cap requires minimum 65% in equity with NO mandatory split across market caps — the fund manager has complete freedom. Multi Cap requires minimum 75% in equity with a MANDATORY minimum of 25% each in large cap, mid cap, and small cap. Flexi Cap = freedom; Multi Cap = forced diversification. Remember this distinction — it appears in almost every NISM mock test.
Why was Multi Cap introduced separately when Flexi Cap already existed?
In September 2020, SEBI noticed that most Multi Cap funds were holding 70-80% in large caps and very little in small caps, defeating the purpose of diversification. SEBI then mandated the 25-25-25 rule for Multi Cap funds. AMCs that did not want to increase small cap exposure reclassified their schemes as Flexi Cap. This is why Flexi Cap became a separate category — it was born out of the Multi Cap controversy.
Which is more suitable for a new investor — Large Cap or Flexi Cap?
For a new investor with limited market experience, starting with a Large Cap fund is generally advisable because the portfolio is anchored in well-established companies with lower volatility. Once the investor is comfortable with market fluctuations (usually after experiencing one correction), Flexi Cap can be introduced for its dynamic allocation. A common mistake distributors make is putting first-time investors directly into small cap funds — the first 20% drawdown panics them out of mutual funds entirely.
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