An Ultra-Short Bond Fund: What Is It?

A bond fund that only makes investments in fixed-income securities with very short maturities is known as an ultra-short bond fund. A fund dedicated to ultra-short bonds will make investments in securities with  maturities shorter than a year. These portfolios provide limited interest-rate sensitivity, reducing risk and total return potential since they concentrate on bonds with very short maturities. On the other hand, compared to money market instruments, this approach often offers better yields with less price volatility than a typical short-term fund.

Please note that this short-term bond fund should not be confused with an exchange-traded fund (ETF) that shorts bonds using leverage.

Having Knowledge about Ultra-Short Bond Funds

Compared to longer-term bond investments, ultra-short bond funds provide investors excellent protection against interest rate risk. Increases in the interest rate will have less of an impact on the value of these funds than on medium- or long-term bond funds because of their very short maturities.

These strategies are often riskier than other money market products, even if they provide more protection against increasing interest rates. Furthermore, unlike ultra-short bond funds, which are no more regulated than regular fixed-income funds, certificates of deposit (CDs) are subject to strict investing requirements.

Bond funds with ultra-short duration against other low-risk options

Understanding the distinctions between ultra-short bond funds and other fixed-income assets with lower risk, such as money market funds and certificates of deposit (CDs), is crucial.

For example, money market funds are limited to investing in short-term, high-quality securities issued by the federal government, U.S. companies, and state and local governments. On the other hand, ultra-short funds are more flexible and usually invest in riskier assets to get more significant returns. Also, there are variations in the net asset values (NAV) of ultra-short bond funds. On the other hand, money market funds try to maintain NAV at $1.00 per share. Strict requirements for maturity and diversity also apply to money market funds. Nevertheless, ultra-short bond funds are exempt from these rules.

Furthermore, ultra-short bond funds are neither covered nor guaranteed by the Federal Deposit Insurance Corporation (FDIC). In contrast, a certificate deposit is insured up to $250,000. The FDIC provides coverage for CDs, ensuring a principal return and a predetermined interest rate because a bank or thrift institution holds the deposit. Moreover, CDs can provide a higher interest return on money deposited than a standard savings account.

When all other things are equal, ultra-short bond funds that hold assets with longer average maturity dates will often be riskier than those with shorter average maturity dates.

Bond Funds with Ultra-Short Credit Quality

Because a credit downgrade or default of portfolio assets might happen and cause losses, investors should learn more about the kinds of securities an ultra-short fund invests in. Compared to typical bond funds, ultra-short funds have less credit risk since short-term bonds mature quickly. A fund’s risk is significantly mitigated if its primary investments are in government securities.

Nonetheless, investors need to be wary of ultra-short bond funds that, to increase income, invest in derivative products, private-label mortgage-backed securities, or bonds of corporations with weaker credit ratings. Higher degrees of investment risk are often associated with those kinds of funds. Any investment offering a higher potential return with no added risk should raise suspicions. By reviewing all of the available information about the fund, including the prospectus, investors may gain more knowledge about ultra-short bond funds.

Excessively Short Bond Funds and Elevated Interest Rates

Specific forms of ultra-short bond funds may be more vulnerable to losses in high-interest rate settings. Researching a fund’s “duration,” which indicates how susceptible the fund’s portfolio may be to changes in interest rates, is crucial for potential investors.

Any investment that offers a higher potential return at no extra risk should be viewed with suspicion. Investors may gain further knowledge about ultra-short bond funds by reading the prospectus and any other information about the fund.

Instances of Extremely Short Bond Funds

A selection of some of the top-performing ultra-short bond funds is shown below:

• Barclays Inv Grd Flt Rt ETF (FLRN) SPDR Blmbg
• The Floating Rate Bond ETF from iShares (FLOT)
• FLTR stands for VanEck Vectors Investment Grd Fl Rt ETF.
• The SHV, or iShares Short Treasury Bond ETF
• SPDR® Bulmbg Barclays T-Bill ETF (1-3 Mth) (BIL)

Conclusion

• Ultra-short funds hold short-term fixed-income assets with maturities of less than a year.
• Compared to regular bond funds, these funds are usually more flexible and aim for greater returns by investing in riskier assets.
• The Federal Deposit Insurance Corporation (FDIC) neither covers nor guarantees funds for ultra-short bonds.
• Specific forms of ultra-short bond funds may be more vulnerable to losses in high-interest rate settings.