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There is a striking rise in the number of target maturity funds in the MF industry. In fact, many fund houses have either launched target maturity funds or are about to launch couple of these funds.
Let us understand the opportunities and risk associated with the target maturity funds.
What are target maturity funds?
These are open-ended passive funds that follow an underlying index and have a specific maturity date. They invest in bonds which form a part of this index and have maturities similar to that of the fund. The bonds are held until maturity and interest receipts during the holding period are reinvested. Upon maturity, investors receive the principal and interest amount.
If the maturity of the underlying index changes, the fund’s maturity also changes. In such a scenario, investors are kept informed.
What are the advantages of these funds?
Since target maturity funds hold bonds until their maturity, they offer some return predictability and are less prone to interest rate risks. Additionally, the credit risk is comparatively low as these funds invest in government securities, PSU bonds, and SDLs (State Development Loans).
Also, these funds offer liquidity and investors can redeem their units at any time. And, since they are passively managed, they command a lower expense ratio.
Further, target maturity funds are more tax efficient than traditional instruments like fixed deposits due to indexation. Units held for more than three years are taxed at 20% after indexation.
What should investors be wary of before investing?
Target maturity funds are a fairly new phenomenon. The first fund was launched in 2019 and hence, sufficient track record is not there. Besides, investors exiting before the fund’s maturity may face interest rate risk and consequently lower returns.
Sandeep Bagla, CEO of Trust Mutual Fund believes that target maturity funds may not be great performers when the interest movements are extreme. He said, “They protect against changing interest rates provided the changes are reasonable.”
He also warned about the opportunity cost involved during rising interest rates and the potential of other debt fund categories to perform better when the interest rates go down through reinvestment.
How are target maturity funds different from fixed maturity plans?
While both have a fixed maturity, target maturity funds are open-ended and fixed maturity plans are close-ended. Also, unlike target maturity funds, fixed maturity plans are listed on exchanges and low transaction volumes constrain liquidity further.
The maturity usually ranges from 3 to 10 years in the case of target maturity funds and from 1 to 3 years in fixed maturity plans. Notably, a fund house recently launched a 15-year target maturity fund.
Who are the ideal investors for target maturity funds?
Suresh Sadagopan of Ladder7 Advisories said that these funds are suitable for long term investors who are not looking for intermittent income during the fund duration. Also, risk-averse investors seeking reasonable returns and protection from interest rate volatility can consider these funds, he said.
To this, Sadashiv Phene added, “Investors’ horizons should align with the maturity of the fund. They stand to lose the advantages if they exit mid-way.”
Does it make sense to invest in these funds at this juncture?
Suresh believes investors can opt for target maturity funds at this juncture. However, Sandeep recommended investing if the funds are due for maturity in three years or less.
On the other hand, Sadashiv believes actively managed debt funds have the potential to generate better returns over the long run.
