With negative yield from equity funds in the past few months and gains from bond funds taking a plunge, cash funds have also emerged top on return charts.

The three-month return on October 31, 2000 from short-term debt funds is 2.34 per cent while medium-term debt funds and diversified equity funds have returned 2.1 per cent and a negative 9.13 per cent, respectively. Investment horizon Short-term debt funds primarily invest in instruments with maturity of less than a year and the investment ambit helps them construct a high credit quality portfolio. Thus, apart from highly liquid money market instruments like commercial papers (CPs), certificate of deposits (CDs), treasury bills, call money market, these funds can invest in instruments with residual maturity of less than a year.

The very short-maturity profile reduces the interest rate sensitivity of the portfolio. This is attributed to the cardinal rule that governs the bond markets - as interest rates rise, price of debt instruments falls and vice-versa. Further, the rise or fall is more pronounced in instruments with a longer maturity tenure. Thus, net asset values of cash funds witness little change vis-à-vis funds with longer portfolio duration during interest rate movements.

Though cash funds are an ideal investment option during times of uncertainty, bond funds are a clear investment choice for the long-term. The two-year return from bond funds is 11.36 per cent on October 31 while those from cash funds is an average 9.43 per cent.

Novertheless, cash funds have certain advantages. First, as these funds come packaged with minimal risks, they are a smart avenue to invest in your short-term surplus.

Let us consider a case where you have arranged a large amount to purchase your dream house. But with the deal a couple of months away, you want the money to earn some decent returns without any risk of losing principal. While stock funds are a strict no, debt funds too have become volatile of late and your time of redemption could coincide with turbulence in debt markets. Second, short-term debt funds are also a worthy replacement for savings account in banks. While cash funds offer liquidity with convenience very close to banks, they also yield much higher returns with a gap as much 4 per cent for the one year ended October 31. Hence, even a risk-averse investor can now earn a better return on his money.

Last but not the least, cash funds are an ideal parking place in times of volatility. Thus, if interest rates are beginning to harden and your bond fund's NAV takes a little dip, you can shift your investments to a cash fund. Today, almost all AMCs offer cash funds and thus, the transfer can be within the same mutual fund. But high level of minimum investment could be a deterrent.

The minimum investment in these funds ranges from a low of Rs 5,000 to Rs 10 lakh. As, in most of the cash funds, the average minimum investment is on the higher side, these funds essentially target corporates and high networth individuals. No wonder, for the differential gains to be meaningful in absolute rupee terms, investment in t hese funds only makes sense if you have sizeable cash holding.

Some of the short-term debt funds provide greater ease of withdrawal by providing limited cheque writing facility for upto 95 per cent of the initial investment besides a systematic withdrawal facility. Almost all funds in this category have no load though few funds charge a redemption fee for withdrawal within 4 to 7 days.

So, while you decide in favour of a short-term debt fund, you will have to be rigorous when you select your fund, as the difference between top and bottom performers in this category is typically small and could be even as low as 10 basis points.

(Value Research)