Fixed Income: A Target Maturity Fund is a Smart Bet

With the low yields of various fixed income products, conservative investors are increasingly investing in open target maturity funds for predictable returns with liquidity. These passive debt funds align their portfolios to the fund’s maturity date and track an underlying bond index. Bonds in the portfolio are held to maturity and all interest payments are reinvested in the fund.

Since target maturity funds invest in government securities, public sector corporate bonds and government development loans, the risk of default is lower compared to other debt funds. The duration of the fund continues to decrease over time and therefore is less subject to price volatility due to changes in interest rates. These funds will help investors plan their investments over a five-year period.

Why target mature funds now?
Target maturity debt funds are suitable for individual investors in two ways. R Sivakumar, Head, Fixed Income, Axis Mutual Fund, says that if the investment horizon matches the target date, these funds behave similarly to Fixed Maturity Plans (FMPs). Unlike an FMP, target maturity funds offer liquidity. “At the same time, the duration decreases over time. Thus, volatility tends to decrease as the fund gets closer to the target maturity. Investors who target specific segments of the yield curve can invest in these funds without being locked in until maturity,” he says.

Interest rates in India and globally are expected to rise as CPI inflation in advanced economies rises above the 5% level. While the Reserve Bank of India maintained an accommodative monetary policy in its February policy, it is expected to gradually raise rates. Markets priced in the rate hikes and the yield curve up to five years is steep, with 1-year G-sec rates at 4.70 and 5-year rates at 6.35.

Murthy Nagarajan, head of fixed income, Tata Mutual Fund, says higher yields in target maturity funds and the benefits of indexing should give investors tax-free returns of 5.5% to 6%. “Given geopolitical uncertainty and expected returns from other asset classes, investors can incorporate target maturity funds into their portfolio,” he says, adding that if investors want greater predictability of returns and have a longer time horizon, they would be better off in the target. maturity funds versus actively managed short-term bond funds.

Associated risks
Although credit risk is low, investors should consider interest rate risk before investing in target maturity funds. Rajeev Radhakrishnan, CIO, Fixed Income, SBI Mutual Fund, says investors should consider the interest rate risks inherent in an open-ended fund in a potentially rising rate environment if their holding period is not aligned with the target maturity of the fund.

“Funds must invest in a defined list of issues which may not be optimal from a yield perspective and there could be an impact on yield resulting from ongoing flows and the deployment of these into corresponding issues. at the index,” he said. Radhakrishnan suggests that fixed-maturity plans with a clearly defined scoring matrix may be superior from a yield perspective compared to similar durations if continuous liquidity is not a requirement.

Investing in a rate hike scenario
In a rising rate scenario, short-term investors should match their time horizon to the duration of the fund. It is preferable to have a shorter duration so that this reinvestment effect outweighs the volatility induced by the rise in rates. Sivakumar says that over a longer horizon, say three years or more, this is less relevant as interest rate cycles in India tend to be relatively short. “So over a period of time, the impact of rising rates on volatility is tempered. Longer-term investors should try to find funds that match their risk profile, meaning that the duration and credit quality matches their needs,” he says.

Target Games
Unlike a fixed maturity plan, target maturity funds offer liquidity
Higher returns in target-maturity funds and the benefits of indexing are expected to deliver 5.5-6% tax-free returns to investors
Target date funds are best suited for situations where the investment horizon matches the target date
Investors should consider interest rate risk before investing in these funds
In a rising rate scenario, go for shorter duration target maturity funds

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