Short Duration Funds — Matching the Scheme to How Long You Have

Bond prices move when interest rates move, and how much they move depends on how long the bond has left. A security repaying next month barely reacts. One repaying in ten years reacts a great deal.

So a scheme holding only very short paper has a value that hardly wobbles, while one holding longer paper can show a noticeable decline over months. That is the whole basis of the ladder, and our page on gilt funds explains the mechanism at the long end.

Each category is defined by a permitted range for how long its holdings run on average, which is why the categories exist as separate things rather than as one debt shelf.

Roughly from shortest to longest, and the horizons below are indicative rather than rules.

• Overnight. Holdings maturing the next business day. Used for money that may move within days.
• Liquid. Very short paper, for weeks rather than months, as our page on liquid funds covers.
• Ultra short and money market. A few months.
• Low duration. Six months to a year or so.
• Short duration. Roughly one to three years.

Beyond that sit medium and long duration schemes, and separately the credit-based and government-paper categories our pages on corporate bond funds and credit risk funds describe.

One question decides it: how long before you need this money?

Pick a category whose typical holding length is no longer than your horizon. If you have eight months, a scheme holding two-year paper can be lower when you need it, and the extra yield you were reaching for is not worth that.

Going shorter than necessary costs you a little and risks nothing. Going longer than necessary is the mismatch that produces the complaint. When in doubt, take the shorter rung, because the penalty is small and the alternative is not.

The ladder describes how long the holdings run. It says nothing about who the borrowers are, and that is a separate risk entirely.

Two schemes on the same rung can hold quite different credit quality. One may be almost entirely in government and top-rated paper, and another may hold a share of weaker borrowers to earn more. The second carries a risk that arrives suddenly rather than gradually, as our page on credit risk funds sets out.

So the check is two-dimensional: the maturity profile and the credit rating breakdown, both of which sit on the monthly document our page on the fact sheet describes. A scheme on a short rung with poor credit quality is not a safe holding, whatever the category name suggests.

Overnight and liquid schemes look almost identical in ordinary conditions and behave differently in unusual ones, which is the only time it matters.

An overnight scheme holds paper maturing the next business day. Everything it owns turns into cash almost immediately, so there is very little that can go wrong with either the price or the ability to pay people who want out.

A liquid scheme holds slightly longer paper, which is why it typically earns a little more. In calm periods that difference is invisible. In a stressed market, where short-term paper becomes harder to sell, the slightly longer holdings are the ones that can be difficult to convert quickly.

That is the whole trade at the bottom of the ladder: a small amount of extra yield against a small amount of extra fragility at exactly the moment you might want the money. For a household buffer, the very shortest rung is usually the right answer for that reason alone.

Three ordinary uses, and none of them is growth.

The buffer, usually at the very short end, where the money must be available at close to a known value, as our page on building an emergency fund covers.

Money with a date within a couple of years, such as a house deposit or a fee, where our page on saving for a car gives one example.

The source of a transfer plan, holding a lump sum while it moves gradually into equity, which our page on the systematic transfer plan describes.

Four things, and none takes long.

• The average maturity or duration, against your own horizon.
• The credit rating breakdown, and how much sits below the top grades.
• The expense ratio, which matters proportionally more here because the outcome range is narrow, as our page on the expense ratio explains.
• The exit load, particularly on the shorter rungs where you may redeem soon.

None of these categories is a substitute for a deposit, since the value can move and nothing is committed. We are distributors rather than investment advisers and we recommend no schemes. If you want to match a specific amount and horizon to the right rung, get in touch.