With awareness of the rise and fall of mutual fund interest rates on secured asset products, many risk-averse investors who were accustomed to conventional products such as fixed bank deposits, PPFs and NSCs, have shifted to debt funds for good reason. Such investors find debt funds less volatile than more popular equity funds and more tax-efficient than their fixed deposits, PPFs and NCI with the potential to deliver better returns.
However, investors are still prone to default risk, i.e. the risk of losing principal and interest payments, and interest rate risk, such as 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 maturity date. These are passive debt funds that track an underlying bond index. Therefore, the portfolio of such funds includes bonds that are part of the underlying bond index and these bonds have maturities that are around the declared maturity of the fund. Portfolio bonds are held to maturity and all interest payments received during the holding period are reinvested in the fund. Therefore, Target Maturity bond funds operate in competency modes like FMPs. However, unlike FMPs, TMFs are open-ended 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 maturity as all bonds in the fund’s portfolio are held to maturity and mature in approximately the same stated maturity period as the fund. By holding bonds to maturity, the fund’s maturity continues to decrease over time and therefore investors are less prone to price fluctuations caused by changes in interest rates.
TMFs are currently engaged in investing in government bonds, PSU bonds and state development loans (SDLs). Hence, 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 a negative development around bond issuers such as the likelihood of a default or credit downgrade.
Despite their open structure and promise of liquidity, target maturity funds should ideally be held to maturity as this provides some predictability of return, an important factor for first-time investors switching from traditional deposits to debt funds.