target maturity fund (TMF) are open-ended index funds that invest passively in bonds of an underlying index with a certain fixed maturity. TMFs mainly invest in government securities, public sector undertakings (PSU) bonds, and state development loans (SDLs) and the instruments are held till the maturity of the scheme. TMFs provide some degree of return prediction for those who stay invested till the maturity of the scheme. For example, the Bharat Bond ETF – April 2030, launched in December 2019, invests in AAA-rated public sector bond instruments in the Nifty Bharat Bond Index – April 2030 and has a current yield of 6.9% to maturity (YTM). This means that if an investor is currently investing in the fund, if held till maturity, he can get a return of 6.9 per cent per annum. This is before deducting the expense ratio of 0.0005%.
Right time to invest?
There appears to be more investor interest for TMF than all others available. loan mf Categories for long term investments, according to Nitin Shanbhag, Head, Investment Products, Motilal Oswal Private Wealth.
Several TMFs with medium to long term maturities have come up in the last one year and a few more have been filed with SEBI for launch soon. The idea is that as the difference between short-term and long-term interest rates widens, a TMF offers investors the opportunity to earn higher after-tax returns on long-term fixed instruments when held until maturity. In India, the yield on long tenure – 10-year government security has increased from 5.8% in mid-2020 to around 6.7% now.
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“In India, the bond market has, to a large extent, pushed up the price of interest rate hikes by the RBI. Tenure of around 4-6 years is considered to be a sweet spot among the many maturity brackets currently available. For bonds with tenor beyond this, the increase in yield from one tenure to the next is not enough,” said Joydeep Sen, an independent debt market analyst. This points out that most of the TMFs being launched by mutual funds recently Why is is designed to mature between 2025 and 2027. The other big differentiating factor for TMFs is the favorable tax treatment when compared to traditional fixed income instruments like fixed deposits.
When investments are held for more than 3 years, these are taxed at 20% after indexation. If held for less than 3 years, short-term capital gains are taxed at the individual’s slab rates. On the other hand, returns from traditional fixed-income investments, regardless of the period of holding, are taxed at the individual’s slab rates. Thus, these instruments are more tax-efficient for those who have been in a higher tax bracket for more than 3 years. Since TMFs are open-ended and provide liquidity, these are also in a way replacing fixed maturity schemes – mutual funds of a fixed duration – like TMFs but closed-ended schemes.
Risks of Investing in TMF
For debt funds, the two primary risks are credit risk and interest rate risk. All existing target maturity funds are investing in either government-backed bonds or AAA rated PSU bonds. Thus, the credit risk is low. Interest rate risk – the volatility of bond prices with changes in interest rates in the economy – will also be reduced when the investment is held until maturity.
In the Potential Risk Class (PRC) matrix disclosed for all debt mutual funds, interest rate risk for the target maturity fund indicates medium to high risk. This is because, if the investment in these funds is withdrawn before maturity, there is a risk of loss in the market. “From a disclosure perspective, there is no certainty that an investor will hold onto the maturity date. On the back of volatility that comes with duration, risk disclosure will be on the higher side,” said Devang Shah, co-head, fixed income, Axis Mutual Fund. If there is a significant increase in returns, investors also run the risk of lower returns. “Moreover, if there is a significant increase in inflation due to higher oil prices and supply-demand mismatch, investors may get negative real returns even if they maintain its maturity,” Dhawan said. .
Who should invest?
Experts say that one should invest in these funds only if the investment tenure matches the maturity of the plan. Abhilash Joseph, Business Head, Finity said, “Investors whose financial goals match the tenure of these funds and want slightly better returns from fixed deposits with better taxability, should consider investing in TMFs.
Shanbhag of Motilal Oswal Private Wealth suggests the barbell approach while investing in TMFs for optimum returns. He said, “We suggest a barbell approach using Target Maturity Funds, i.e. 65-70% allocation to a 3-5 year maturity fund (currently 5.75-6.00% p.a.), and balance the balance. 10-year maturity to be allocated to the fund. (currently yielding 7.00-7.10%). This will ensure optimum combination of overall portfolio return and tenor.”
“Investors can consider investing between 25 to 35% of their fixed income allocation in this category if they do not require liquidity. Investors can consider schemes with maturities of 2026/2027 or 2031/2032 depending on their holding period capacity and investment laddering needs, where different schemes mature at different times to reduce reinvestment risk. “
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