What are Target Maturity Funds? Should you Invest in them?

India, as a country, has always focused on savings, with most investors preferring guaranteed return investments. No wonder fixed return generating instruments still continue to be popular among Indians. Bank accounts, fixed deposits, post office deposits, and other small savings schemes are some of the most commonly used investment avenues in the country. However, in recent years, people have started realizing the benefit of debt mutual fund investments. These offer better returns and tax-efficient gains when compared to traditional investment options. Within debt funds, one of the recent entrants is Target Maturity Funds. 

Target Maturity Funds come with a specified maturity date that is in alignment with the expiry date of the debt instruments that are included in the portfolio. These funds are fast grabbing the attention of risk-averse investors as they come with a comparatively lower interest rate risk and tend to offer predictive and stable returns. Here, we will discuss Target Maturity Funds in detail and highlight associated benefits and risks to aid informed investment decisions.

What are Target Maturity Funds?

Target Maturity Funds adopt a passive investment approach and primarily invest in bonds that are form part of the underlying index, like Nifty State Development Loans(SDL), Nifty PSU bond, etc. These funds are structured in the same manner as an index fund or an ETF since they mirror the underlying index composition and track the index performance. Therefore, the idea is to match the index’s performance and not to outperform it.

Target Maturity Funds have a pre-defined maturity, which will be stated in the fund name. These funds invest in a collection of bonds that are part of the index that the fund tracks. The bonds have similar maturity dates as the fund and are held until maturity. The investor gets back his/her principal investment and earns interest throughout the investment period. However, it is important to note that, like any other debt mutual fund; the principal is not guaranteed and is, therefore, a risk element attached to this form of investment.

Why should investors invest in Target Maturity Funds?

As per the strategy adopted by these funds, there are many benefits of investing in them. Here are some of the benefits that investors can avail from Target Maturity Fund investments:

• Flexibility: These funds offer the flexibility of tenures as they primarily identify attractive yield timelines. They adopt a structure based on reducing residual maturity. In simple terms, this means that with every passing year, the maturity of the bonds included in the portfolio keeps reducing. Thus, the duration risk is pushed down and the predictability of the fund returns rises.

• Lower risk of interest rate changes: Since these funds hold debt securities until they reach maturity, their returns are unaffected by any rising interest rate threats. Target Maturity Funds, therefore, carry lower interest rate risk. In the case of traditional debt funds, the returns can decrease substantially due to this risk.

• Tax efficiency: Apart from offering stability of returns and clear visibility, these funds are also tax-efficient when compared to traditional investment avenues. The returns from these funds are taxable at 20% after indexation for an investment period over 3 years. Investors whose income levels are within the higher tax brackets can therefore gain better post-tax returns from these as compared to fixed deposits that are taxed as per the income tax slab rates.

What are the factors to note before investing in Target Maturity Funds?

Some aspects to keep in mind while investing in Target Maturity Funds are:

• No historical performance data: One of the drawbacks of this fund category is the absence of a historical performance track record. Therefore, while it may suit the risk appetite of risk-averse investors, it can put investors in a fix when it comes to calculated decision-making.
• Limited fund manager intervention: Since the investments of these are restricted to bonds with specific maturities and also specific bond categories that are constituents of the underlying index, there is little to no intervention by the fund manager.
• Scope of tracking error: Tracking error is the difference between the fund returns and returns of the underlying index. A high tracking error signifies a higher variance between the fund returns and the benchmark’s returns. A lower tracking error is preferable since it means that fund and benchmark returns do not have much difference. Investors must be weary about investing in funds that have a high tracking error.

Is it wise to invest In Target Maturity Funds?

As the ongoing Ukraine-Russia war has economists worried about rising inflation in the near future, combined with no rate cuts expected from the RBI, investors must make wise and careful investment decisions. It is sensible to invest in funds with maturities that broadly align with the individual investment horizons.

Thus, if an investor has a medium to a long-term goal, investing in Target Maturity funds may be a wise choice. However, with liquidity benefit, there is also an attached interest rate risk as yields may rise and bond prices may fall. Investors must therefore consider investing in Target Maturity Funds only if they are comfortable to remain invested until maturity.

Conclusion

As passive investment strategy is fast picking pace, more mutual fund houses are launching various passive funds. Due to constant turbulence in the equity markets, both investors and fund houses prefer to focus on passive debt funds. Target Maturity Funds offer the unique benefits of a low to medium risk structure combined with a passive investment approach. Investors who had been focusing on traditional investment forms can explore this investment opportunity to meet specific and dated financial goals.

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