Passive investing is not just about equity funds. Mutual funds offer a number of passive options in the debt category too. They include target maturity funds, liquid ETFs and gilt index funds.
There have been several launches in this category in the last few months. In fact, passive debt funds have been gaining popularity as they hold numerous advantages over the active ones. The advantages include:
Low cost: Given their passive nature, these funds have considerably lower expense ratios compared to active ones. As debt fund returns are on the lower side, any savings in costs can make a big difference.
Negligible credit risk: Passive debt funds hardly invest in low rated papers. While target maturity and gilt funds comprise mostly of government securities, state-development loans and bonds issued by PSUs, liquid ETFs invest only in securities with overnight maturities like tri-party repo and repo.
These high credit papers ensure that passive debt funds carry negligible credit risk.
Predictability of returns: The biggest advantage of target maturity funds is that they offer predictable returns, provided one holds the investment till maturity. If redeemed before maturity, the return can be higher or lower, depending on change in interest rates.
Who should invest in these funds?
There are three broad categories of passive debt funds and each is meant for a specific set of investors. Let's take a look at them one by one:
Target maturity funds (TMF)
These are debt funds (index funds or ETFs) with a defined maturity that passively invest in bonds that constitute their benchmark index. The returns from these funds, as explained above, is predictable.
TMF makes sense for those investors who are looking for a low-cost alternative to bank fixed deposits. TMFs are better placed on the tax front as compared to bank FDs as they come with indexation benefits. This makes TMFs attractive option for those in the higher tax brackets.
However, these funds are beneficial only for those investors who can hold the investment for at least 3-4 years. Redeeming the investment in a short time can lead to lower returns. Such investors will also lose out on the indexation benefits as they come into play only after 3 years.
Passive gilt funds
These funds do not have a defined maturity. They invest predominantly in g-secs that comprise the most actively traded segment of the bond market.
They carry some interest rate risk and are suitable for those investors with high-risk appetite. The investor should also be prepared to stay invested for the long term to garner reasonable returns.
Liquid ETFs
Liquid ETFs are more like active overnight funds as they invest in securities with overnight maturities like tri-party repo and repo. Active liquid funds invest in securities having maturity of up to 91 days such as commercial papers, certificates of deposit and treasury bills.
Liquid ETFs are the best fit for investors who are looking for a money parking option that's completely safe and also generates some returns. Investors who are into active trading use the option to park the cash (in the demat account) while they wait for the right time to buy shares.
