Ultra-Short Bond Fund

What Is an Ultra-Short Bond Fund?

An ultra-short bond fund is a bond fund that invests only in fixed-income instruments with very short-term maturities. An ultra-short bond fund will invest in instruments with maturities of less than one year. Because of their focus on bonds with very short durations, these portfolios offer minimal interest-rate sensitivity and therefore lower risk and total return potential. This strategy, however, tends to offer higher yields than money market instruments with fewer price fluctuations than a typical short-term fund.

Note that a short-term bond fund like this should not be confused with a bear bond fund or ETF that goes short bonds on a leveraged basis.

Key Takeaways

  • Ultra-short funds hold short-term fixed-income securities, maturing in less than one year.
  • These funds can have more freedom and typically pursue higher yields by investing in riskier securities than traditional bond funds.
  • The Federal Deposit Insurance Corporation (FDIC) does not cover or guarantee ultra-short bond funds.
  • In high-interest rate environments, ultra-short bond funds of certain types may be extra susceptible to losses.

Understanding Ultra-Short Bond Funds

Ultra-short bond funds give investors more significant protection against interest rate risk than longer-term bond investments. Since these funds have very low durations, increases in the rate of interest will affect their value less than a medium- or long-term bond fund.

While this strategy offers more protection against rising interest rates, they usually carry more risk than most money market instruments. Further, certificates of deposits (CDs) follow regulated investment guidelines, but an ultra-short bond fund has no more regulation than a standard fixed-income fund.

Ultra-Short Bond Funds vs. Other Low-Risk Investments

The differences between ultra-short bond funds and other fixed-income investments with relatively low risks–such as money market funds and certificates of deposit (CDs) are important.

Money market funds, for instance, may only invest in high-quality, short-term investments issued by the U.S. government, U.S. corporations, and state and local governments. Conversely, ultra-short funds have more freedom and typically pursue higher yields by investing in riskier securities. Also, the net asset values (NAV) of ultra-short bond funds fluctuate. By contrast, money market funds try to keep NAV stable at $1.00 per share. Money market funds are also subject to strict diversification and maturity standards. However, these regulations do not apply to ultra-short bond funds.

Furthermore, the Federal Deposit Insurance Corporation (FDIC) does not cover or guarantee ultra-short bond funds. A certificate deposit, on the other hand, is insured up to $250,000. The FDIC covers CDs, which promises a return of principal and a specified rate of interest because a bank or thrift institution holds the deposit. Also, CDs typically offer a better interest rate on deposited funds than a regular savings account.

Ultra-short bond funds that hold securities with longer average maturity dates will tend to be riskier than a fund with shorter average maturity dates, all other factors being equal.

Credit Quality of Ultra-Short Bond Funds

Investors should research the types of securities in which an ultra-short fund invests because a credit downgrade or default of portfolio securities may occur that can result in losses. Because short-term bonds mature relatively quickly, however, credit risk is less of a factor for ultra-short funds compared to traditional bond funds. This risk is further reduced if a fund principally invests in government securities.

However, investors should be aware of ultra-short bond funds that invest in bonds of companies with lower credit ratings, derivative securities, or private-label mortgage-backed securities in an attempt to boost yield. Those types of funds tend to be subject to higher levels of investment risk. As always, be skeptical of any investment that promises you a greater potential for return at no additional risk. Investors can learn more about an ultra-short bond fund by reading all of the fund’s available information, including its prospectus.

Ultra-Short Bond Funds and High-Interest Rates

In high-interest rate environments, ultra-short bond funds of certain types may be extra susceptible to losses. It is important for prospective investors to research a fund’s “duration,” which gauges how sensitive the fund’s portfolio may be to fluctuations in interest rates.

Any investment which promises a more significant potential for return at no additional risk should raise skepticism. Investors can learn more about an ultra-short bond fund by reading all of the fund’s available information, including its full prospectus.

Examples of Ultra-Short Bond Funds

Below is a shortlist of some of the better performing ultra-short bond funds:

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