Rising popularity of target maturity funds in recent times

When it comes to passive investing in India – passively managed equity-oriented funds i.e., equity-oriented index funds and equity exchange trade funds (ETFs) along with gold ETFs have been most popular among investors.  But recently the passively managed debt funds are also making the headlines given the launch of the target maturity funds (TMFs) by several fund houses. One of the reasons for the rising popularity of the TMFs is predictability of returns they offer and also their consistency style wherein investors are aware of the underlying portfolio quality, maturity profile. Besides, in the current scenario of rising inflation and changing interest rate TMFs also enables to choose a fund whose maturity aligns closely with their own goals and investment horizon.  Let us understand more about TMFs in this article.

Target Maturity Funds: Key Features  

TMFs are open ended passively managed funds offered either as target maturity debt index fund or target maturity bond ETFs. In TMFs, the fund house creates a portfolio which will mirror underlying debt index comprising of government securities (g-secs), public sector undertaking (PSU) bonds and SDLs (State Development Loans). These schemes have a defined maturity and invest in bonds of similar maturity and once the fund matures the investment proceeds are returned back to investors.

Investors will be obviously wondering how TMFs is different from the erstwhile fixed maturity plans (FMPs)?   Difference lies in the structure. FMPs were closed ended funds wherein after the new fund offer (NFO) investor cannot invest. While they could sell the FMPs prior to maturity but trading is relatively less which restricted their liquidity.  In case of TMFs, investors can buy and redeem any time after their launch and prior to maturity.  In addition, TMFs have longer tenure options giving them edge over FMPs. Some of the key merits of investing in TMFs are as follows:

Target Maturity Funds: Merits   

• In the backdrop of the credit crisis and liquidity challenges which engulfed the debt funds over past few years, investors look at debt-oriented funds which score high on safety. TMFs fits well as they invest in G-secs, PSU bonds offering high degree of safety to investors.
• TMFs are simple roll down products i.e., the fund manager will construct a portfolio of securities with a defined maturity and allow the maturity to fall in line with the fund’s tenure. This makes it easy to track, helps to lock the prevailing yields and also provide some predictability in returns. Investors can expect returns closer to the indicative yields at the time of investing by looking at the yield to maturity (YTM). YTM is the indicator of the expected return from the fund should the portfolio of the fund is held till maturity. The YTM details can be obtained from the fund house website.
• TMFs are passively managed funds they tend to have relatively lower expense ratios compared to actively managed debt funds. An expense ratio is important as it helps to understand how much the investor will pay for the cost and higher expense ratio means bigger the cut which over long run impact returns.
• TMFs offers flexibility to investors to choose from wide range of tenures such as 3 years, 5 years, 7 years etc. This makes it convenient for investors to invest in TMFs in line with their goals and investment horizon.
• Investment in TMFs for the period of 3 years or more offers indexation benefits. This could be beneficial to investors falling in the highest tax bracket as long-term capital gains is taxed at 20% post indexation compared to traditional bank deposit where they are taxed as per the income tax slab.

Target Maturity Funds: Beware of the risks involved

TGPs offers an additional opportunity to investor to diversify their investment in the debt space however make a note of the following risk factors:

• Investors often uses past performance as an important yardstick to evaluate the fund. Although past performance is not a guarantee of good performance in the future. It is good indicator. TMFs are relatively new product and hence there is no track record which investors can analyse prior to investing.
• TMFs are prone to tracking error since they replicate a bond index. Tracking error refers to difference between actual and benchmark returns. A higher tracking error indicates greater divergence between fund and benchmark returns and vice versa.
• In event of the early exit from TMFs prior to maturity there is interest rate risk thereby lowering returns.
• Interest rate is currently low and with investment in TMFs investors get locked in at prevailing interest rates and stand to lose in event of the gradual increase in the interest rates. In event of rapid increase in interest rates the net asset value of these schemes is likely to come under pressure as bonds and yields are inversely related leading to mark-to-market losses for investors.

Investors must closely evaluate all the aforementioned pros and cons before investing. Also keep in mind that investing in target maturity bond exchange traded fund (ETFs) will require demat account. With the wide range of the TMFs available to investors it is crucial to check the fund house history, quality of the underlying portfolio and returns expected which can help investors to make the prudent choice.