What is an ultra-short bond fund? Pros and cons

An ultra-short bond fund is a type of bond fund that buys fixed-income instruments that have short maturities. Ultra-short bond funds typically invest in instruments with maturities of up to one year.

There is less risk of extreme price fluctuations associated with ultra-short bond funds compared to other types of short-term fund strategies.

They are a popular haven for those looking to earn more than the near-zero yields of money-market mutual funds – without tying up their money in a certificate of deposit or taking higher interest-rate risk with longer-term debt funds.

The advantages of ultra-short bond funds:

  • Potentially higher yields compared to money market accounts and short-term bonds.
  • More protection for investors against interest rate risk.
  • Interest rate changes don’t affect the value of the fund as much as long-term funds.

The disadvantages of ultra-short bond funds:

  • High annual expense ratios (normally between 0.36 and 0.80%). Expense ratio is how much mutual fund managers charge you annually for their service.
  • There is still risk – mainly credit and default risk.
  • Not subject to as much regulation compared to a typical fixed-income fund.
  • These funds are not FDIC insured – which means that  you can potentially lose all your money.

Why do some investors opt for an ultra-short bond fund instead of money market funds?

This basically comes down to the length of maturity. A money market fund must have an average maturity of 90 days or less, whereas an ultra-short bond fund can have average maturities between 3 months and 12 months. Therefore, an ultra-short bond fund can take full advantage of the upward trend of the yield curve – the longer the maturity date the more potential yield.

The US Securities and Exchange Commission issued the following warning regarding Ultra-Short Bond Funds:

“If you are considering investing in an ultra-short bond fund, keep in mind that ultra-short bond funds can vary significantly in their risks and rewards. In fact, some ultra-short bond funds may lose money despite their investment objective of preserving capital.”

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