Target maturity funds (TMFs) are a sort of open-ended debt funds that offer you fixed maturity dates. The portfolios of these funds carry bonds whose maturity date is aligned with the fund’s target maturity date, and all bonds are held until maturity. While this helps reduce interest rate risk and makes returns more predictable, investors should keep in mind the drawbacks of TMFs before investing in these funds
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Target maturity bond funds are a new category of debt fund and so there are few options available in this space. This may limit the choice of the available deadline for an investor, meaning that investors who want a specific maturity horizon may not be able to find a suitable fund. In addition, the category has no performance track record to rely on
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The advantages of the target maturity fund include the mitigation of interest rate risk and the visibility of the return. But both of these benefits can only work if the investor stays invested in the fund until it expires. So, investors may end up earning lower returns and also be prone to interest rate volatility if they have to liquidate their investments before maturity during an emergency. TMFs should only be considered if you have an average long-term goal of 5-7 years and if you can maintain your investments until the fund expires
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The biggest disadvantage of target maturity funds is that investors are stuck in prevailing interest rates and this could have a negative impact on overall returns, especially when interest rates are likely to apply in the future. This is usually the case when the economy is just coming out of a recession or the government is likely to withdraw an ongoing stimulus package because, in both of these scenarios, interest rates are usually at their lowest and are therefore likely to remain alone. Rising interest rates have a negative impact on bond prices and on debt fund yields
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Because TMFs invest in an underlying bond index, these funds are as prone to tracking errors as any other index fund. While the category has no performance history, the underlying bond indices may be a reasonable indicator of the expected returns from a specific TMF. However, the tracking error, that is, the difference between the actual returns of the funds and the performance of the benchmarks, may be spoilsports here in exchange
for predictability.
Being passive in nature, the fund manager has a limited purpose to manage various risks if the outlook of the debt market were to change in the short term, such as a change in a credit rating or RBI that brings changes to interest rates. The manager has no choice but to keep the bonds in the underlying index regardless of his outlook. So, this may not be favorable to investors who are looking for short-term investments in debt funds. It would be better to invest in shorter-maturity funds instead of TMF
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We recommend that you carefully weigh the pros and cons of Target maturity funds before choosing to include them in your investment portfolio. In addition, a Demat account is mandatory to invest in Target maturity funds available in ETF format, which could be a limitation if you don’t have
one.
