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
.
With the awareness of the rise and fall in interest rates of mutual funds on guaranteed savings products, many risk-averse investors who were used to conventional products such as fixed bank deposits, PPFs and NSCs, moved to debt funds for good reason. Such investors find debt funds less volatile than the most popular equity funds and more tax-efficient than their fixed deposits, PPFs and NSCs with the potential to offer better returns. However, investors are still prone to default risk, namely the risk of losing principal and interest payments, and interest rate risk, that is, price fluctuations due to changes in interest rates
.
Target maturity funds (TMFs) help investors better manage the risks associated with debt funds by aligning their portfolios with the fund’s expiration date. These are passive debt funds that track an underlying bond index. Therefore, the portfolio of these funds includes bonds that are part of the underlying bond index, and these bonds have maturations that are around the fund’s stated maturity. The bonds in the portfolio are held until maturity and all interest payments received during the holding period are reinvested in the fund. Therefore, Target maturity bond funds operate in an accrual mode like the FMPs. However, unlike FMPs, TMFs are open in nature and are offered as target maturity debt index funds or target maturity bond ETFs. Therefore, TMFs offer greater liquidity than FMPs.
TMFs have a homogeneous portfolio in terms of duration, since all the bonds in the fund’s portfolio are held until maturity and mature more or less at the same time as the fund’s stated maturity. By holding bonds until maturity, the duration of the fund continues to decrease over time and therefore investors are less prone to price fluctuations caused by changes in interest rates
.
The TMFs are currently in charge of investing in government bonds, PSU bonds and SDL (State Development Loans). Therefore, they carry a lower risk of default than other debt funds. Because these funds are open-ended, investors can choose to withdraw their investment in the event of any negative development surrounding bond issuers, such as the likelihood of a default or a credit
downgrading.
Despite their open structure and the promise of liquidity, target maturity funds should ideally be held until maturity as this provides a certain predictability of return, an important factor for investors who are switching from traditional deposits to debt funds for the first time.
