With the awareness of mutual funds rising and falling interest rates on guaranteed savings products, many risk-averse investors who were used to conventional products like bank fixed deposits, PPFs, and NSCs, have moved towards debt funds for good reasons. Such investors find debt funds to be less volatile compared to the more popular equity funds and more tax-efficient than their fixed deposits, PPFs, and NSCs with the potential of offering better returns. However, investors are still prone to default risk i.e risk of losing principal and interest payments, and interest rate risk i.e price fluctuations due to changes in interest rates.
Target maturity funds (TMFs) help investors navigate the risks associated with debt funds better by aligning their portfolios with the maturity date of the fund. These are passive debt funds that track an underlying bond index. Thus, the portfolio of such funds comprises of bonds that are part of the underlying bond index, and these bonds have maturities hovering around the fund’s stated maturity. The bonds in the portfolio are held to maturity and all interest payments received during the holding period are reinvested in the fund. Thus, Target Maturity bond funds operate in an accrual mode like FMPs. However, unlike FMPs, TMFs are open-ended in nature and are offered either as target maturity debt index funds or target maturity bond ETFs. Thus, TMFs offer greater liquidity than FMPs.
TMFs have a homogenous portfolio as far as duration is concerned since all the bonds in the fund’s portfolio are held to maturity and they mature around the same time as the fund’s stated maturity. By holding the bonds to maturity, the duration of the fund keeps falling with time and hence investors are less prone to price fluctuations caused by interest rate changes.
TMFs are currently mandated to invest in government securities, PSU bonds, and SDLs (State Development Loans). Hence, they carry lower default risk compared to other debt funds. Since these funds are open-ended, investors can choose to withdraw his/her investment in case of any adverse development around the bond issuers like likelihood of a default or a credit downgrade.
Despite their open-ended structure and promise for liquidity, Target Maturity Funds should ideally be held upto maturity as this provides some predictability of return, a factor important for investors shifting from traditional deposits to debt funds for the first time.
