Target Maturity Funds (TMFs) have been the talk of the town for a while now. But, before we understand what they are, let’s quickly recap what are debt mutual funds (since Target Maturity Funds are a type of debt mutual fund).
Debt mutual funds are a type of mutual fund that invests in fixed-income generating securities like government bonds, and corporate bonds. They are often seen as a substitute for your more traditional debt investments like FDs, PPF, National Savings Certificates, etc.
What are Target Maturity Funds?
TMFs are debt mutual funds that are akin to index funds or ETFs in that it pools your money and track an underlying bond index. It comes with a maturity date, and unlike fixed maturity plans (FMPs) these funds do not have any holding period, i.e you can exit anytime you want.
TMFs are allowed to invest only in government securities, PSU Bonds, and State Development Loans (SDLs) making it less risky than investing in other debt instruments. Also, since they are passively managed – it saves you time and energy by helping you get market returns with little effort.
Target Maturity Funds gained popularity for a wide variety of reasons, them being:
- Open-ended nature: As mentioned earlier, you do not have a specific exit point for TMFs, and can therefore sell them whenever you want. But, it is usually not recommended to do so since holding it till the maturity date (which is the maturity date of the bonds the TMF has invested in) helps you to avoid taking any interest rate risks and thereby provides you with better predictability of returns.
- Simplified tax structure: TMFs are taxed just like other debt mutual funds. Long-term capital gains (holding period > 3 years) are taxed at 20% along with indexation allowance (adjusting the cost of acquisition of security to inflation) and Short term capital gains (holding period < 3 years) are taxed as per your tax slab. Unlike FDs where the accrued interest is added to your taxable income every year and taxed at your slab rate, debt mutual funds like TMFs are generally seen as more tax-efficient investment vehicles.
- Safety from interest rate movements: Bonds in a Target Maturity Funds portfolio is similar in nature as far as duration (Duration measures the interest rate sensitivity of a bond) is concerned since all of them are held till maturity and are slated to mature around the same time as the fund’s maturity. The maturity of a TMF is usually mentioned in its name e.g. Edelweiss Nifty PSU Bond Plus SDL Index Fund – 2027. By holding these bonds to maturity, the duration of the fund keeps falling and hence the investors are less affected by any price fluctuations due to interest rate changes.
The flip side of TMFs is not a lot but still should not be ignored:
- Lack of past performance details: The major disadvantage of a TMF is the lack of any historical data on its past performance. As a result, you are often dealing with less information when evaluating a fund than you would have otherwise.
- Early exit error: Target Maturity Funds are open-ended in nature allowing you to exit whenever you want. However, that convenience also comes with a caveat that you may be subject to interest rate risk. For e.g. In a rising interest rate environment, TMFs may temporarily see a drop in their value as the new bonds issued by other issuers with higher interest rates become more attractive. Hence, it is not really advised to time your investment in a TMF and instead stays invested through the maturity date.
- Another side of the passive coin: Since Target Maturity Funds are passive in nature, the fund manager often has very limited scope to actively manage the bond portfolio in response to the prevailing interest rate environment or a change in the credit rating of the issuer. Hence, the manager has no choice but to hold on to the bonds.
Is it for you?
If you are looking to lock in your returns and like the predictability of getting an assured return, you should invest in Target Maturity Funds. But, you should have the right temperament to hold the fund until its maturity and not make any hasty decisions in between.
The recent hike in the interest rate by RBI makes the newly-launched TMF’s overall yield more attractive and lucrative and therefore it can be a good addition to your debt investment portfolio.