A mutual fund is a professionally managed company that collects the money of many investors and invests it in securities such as stocks, bonds and short-term debts, equity or bond funds, and money market funds.
Mutual funds are a good investment for investors who want to diversify their portfolio. Instead of focusing everything on one company or sector, a mutual fund invests in different securities to try to minimize portfolio risk
The term is typically used in the United States, Canada, and India, while similar structures around the world include the SICAV in Europe and the open-type investment firm in the United Kingdom.
Debt mutual fund investors face two primary risks, interest rate risk and credit risk. While long-term G-Secs deal well with credit risk, they are prone to the risk of high interest rates. On the other hand, short-term funds or liquid funds offer better management of interest rate risk, but suffer from credit quality problems.
The FMP and Target Maturity funds have fixed deadlines and are therefore in a better position to manage interest rate risk through a purchase and hold strategy. However, target maturity funds score a few points above FMPs in some respects. In addition to facing interest rate risk, they are also in a better position to manage credit risk than FMPs since their portfolio consists of G-sec, government development loans, and AAA-rated PSU bonds
FMPs are tight funds and even though they are listed on stock exchanges, they do not offer much liquidity due to low transaction volumes. Target maturity bond funds are open in nature and therefore offer better liquidity. Target maturity funds are also available in three different formats, namely, they are available as target maturity bond index funds and target maturity bond ETFs. Therefore, target maturity funds offer investors more choices in terms of fund structure.
Being passive in nature, target maturity funds have a lower expense ratio than FMPs in which the fund manager must build the portfolio. Target maturity funds also offer more choice in terms of maturity ranging from 3-10 years, while most FMPs are usually in the 1-3 year range. Therefore, FMPs may not be suitable for investors with longer objective horizons
The FMPs score compared to the target maturity funds in one aspect because they are closed. While this limits their liquidity, it also forces serious investors to remain invested until the fund expires and thus protects them from interest rate risk. Because Target maturity funds are open-ended, that doesn’t mean you should invest in them without committing to stay invested until their expiry date. If you don’t, the entire premise of locking in yield and interest rate risk protection is lost. Therefore, target maturity funds are only suitable for those investors who can remain standing until the fund’s expiry date and the entire target horizon corresponds to the fund’s expiry date