What are Target Maturity Mutual Funds (TMFs) ?

One of the primary reasons people invest in debt funds is to make their portfolios stable. But the unprecedented volatility in the debt market and the collapse of multiple debt schemes from a leading fund house have made people wary of this market segment.If you want to invest in debt mutual funds but are concerned about these recent events, then target maturity funds can be an excellent choice for your portfolio. Here are some of the most important things you should know about these mutual funds-

Target maturity funds are passive debt funds that come with a fixed maturity date. At the heart of these schemes is a bond index made up of the bonds included in its portfolio. The fund maturity aligns with the maturity of the bonds in which the scheme has invested.All the bonds included in the portfolio are held until maturity. Any interest received during this period is reinvested in the same bonds. Thus, these schemes operate on an accrual model, similar to FMPs (Fixed Maturity Plans) . However, TMFs are open-ended schemes with greater liquidity compared to FMPs.

Here are some of the reasons why you can consider investing in TMFs-

Potentially Higher Returns

As mentioned above, target maturity funds invest in various fixed maturity bonds. The interest rate of these bonds vary. Thus, compared to investing in a scheme with a single bond in its portfolio, it can be more rewarding to invest in TMFs.

Lower Volatility

TMFs hold their bond investments until maturity. Due to this, the interest rate fluctuations are considerably lower. These fluctuations impact the mark-to-market (MTM) in other debt mutual funds. But MTM does not reflect in target maturity schemes due to their low-interest rate volatility.

Open-Ended Schemes

Unlike FMPs, TMFs are open-ended schemes. Investors are free to invest and redeem as and when they like. However, based on when investors redeem their investment, they'll either have to pay long-term or short-term capital gains tax.

Tax Efficiency

Compared to several other single-bond funds, TMFs are more tax-efficient as they offer indexation benefits on long-term gains. Thus, when calculating the long-term capital gains from a target maturity fund, you can adjust the purchase price according to the inflation index to reduce the taxable gains.

Even the safest mutual funds come with a certain level of risk. The same is true for TMFs. If you are planning to invest in these schemes, then here are some of the downsides you should be aware of-

Early Exit Risks

TMFs are open-ended schemes. Investors can redeem their investment even before the bonds mature. But the interest rate risks are significantly higher in the case of premature withdrawals. For instance, if the overall interest rates are rising in the country, then a premature withdrawal might also lead to losses.

Inadequate Track Record

As target maturity funds are relatively new to the markets, there is limited data to analyze and compare their performance across various economic cycles. As a result, you’ll mostly be relying on the claims of the fund house for your investment.

Passive Schemes

While this can be an advantage if you are a risk-averse investor looking for a mutual fund that can mirror the returns of an index, the strategy might not work for everyone. As TMFs track an index, the fund managers don’t have a lot of flexibility in terms of adjusting the portfolio components.

Tracking Error

Tracking error is common in schemes with an underlying benchmark. If the tracking error is high, then the returns delivered by the scheme can significantly vary from the returns generated by the index.

The current volatility in the debt market and the rising inflation risk make TMFs an ideal addition to a diversified portfolio. But these schemes are only recommended if you have a medium-to-long-term investment horizon. Also, note that TMFs come with moderate interest rate risk. If the yields rise, then the bond prices will suffer and negatively impact the NAV of TMFs.Before investing, ensure that you clearly understand how these funds work and the risks they are prone to. A professional investment advisor can also help you make the right investment decision.

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.