Are constant maturity funds better than target maturity funds?

Name withheld on request

Constant Maturity Fund is quite different from Target Maturity Fund. They are not substitutes for each other.

The 10 Year Constant Maturity Fund aims to maintain an average portfolio maturity of 10 years at all times. It can do this by combining gilts (government bonds) of different maturities, such that the maturity of the portfolio is around 10 years, or by holding gilts with a maturity of 10 years. It doesn’t matter when you invest in the fund – the maturity will always be around the same level. In such funds, you take the interest rate risk. That is, changes in the interest rate cycle will affect bond prices and hence the fund’s returns. A rising rate cycle pulls down returns as bond prices fall, and vice versa.

The returns of a constant maturity fund can change from portfolio yield to maturity as you invest; Not only because of the impact of the rate cycle but also because funds can actively book profits when bond prices rise to bulk up returns. You can hold these funds for any number of years.

A target maturity fund, on the other hand, does not maintain a specific maturity – it is only the maturity date that is fixed. As the target date approaches, the maturity of the fund will reduce. These funds match the maturity dates of the bonds held in the portfolio, and do not actively manipulate it.

Here, if you hold the fund till maturity, the interest rate effect is largely nullified. You are more likely to get returns around the time of your entry till maturity.

If you want to include targeted maturity funds in your portfolio, try to match your holding period with the maturity of the fund. This limits both reinvestment risk and interest rate risk.

Shrikant Meenakshi is the Co-Founder at PrimeInvestor.