Target Maturity Funds: A Guide To Investing Wisely

Target maturity funds are passive debt mutual fund schemes that track an underlying bond index. They are open-ended debt funds with a specific maturity date, and they are similar to fixed maturity plans (FMPs). These funds hold a collection of bonds with similar maturity dates, generally until the maturity date. On the maturity date, investors receive the principal amount along with accrued interest. Target maturity funds can be a good investment option for those seeking predictable returns and capital preservation. They are also tax-efficient, offering indexation benefits and long-term capital gains tax computation.

How target maturity funds work

Target maturity funds are passive debt mutual fund schemes that track an underlying bond index. They are open-ended funds with defined maturity dates. On the maturity date, investors receive the principal amount along with accrued interest. These funds can be exchange-traded funds or index funds.

As per SEBI regulations, target maturity funds can invest only in government securities (G-Secs), state development loans (SDLs), and PSU bonds that mirror an underlying bond index. G-Secs, SDLs, and PSU bonds enjoy sovereign or quasi-sovereign status, ensuring a high credit quality for target maturity funds.

Target maturity funds hold bonds in their portfolio until maturity and roll down the maturities of their bonds over time. For example, if you buy a 5-year bond intending to hold it until maturity, it becomes a 4-year bond after the first year, a 3-year bond after the second, and so on.

The yield curve is typically upward-sloping, meaning that longer maturities offer higher yields. On the other hand, interest rate risk is directly related to the maturity of a bond. By rolling down the maturity, investors can maintain a higher yield on their portfolio while reducing overall risk. This makes target maturity funds attractive when interest rates are high and expected to decrease in the future.

The bonds in target maturity funds' portfolios pay regular interest (coupons), which are reinvested in the fund, allowing investors to benefit from compounding. On maturity, investors receive the principal amount (face value) along with any accrued interest.

Target maturity funds offer advantages such as flexibility, tax efficiency, and protection from rising interest rates. However, they also have limitations, including a lack of track record and limited flexibility for fund managers due to their specific investment parameters.

Advantages of target maturity funds

Target Maturity Funds (TMFs) are a type of passive debt mutual fund that tracks an underlying bond index. Here are some advantages of investing in TMFs:

• Open-ended schemes with high liquidity: Unlike Fixed Maturity Plans (FMPs), which are close-ended, TMFs are mostly open-ended. This means that investors can redeem their investment at any time. However, they may be subject to capital gains tax, depending on the time of redemption. TMFs offer higher liquidity compared to FMPs.
• Tax efficiency: TMFs provide indexation benefits when computing long-term capital gains tax, resulting in better post-tax returns compared to other bond funds. If the target maturity date is more than three years from the date of investment, investors can benefit from long-term capital gains taxation.
• Stable and predictable returns: TMFs have a defined maturity date, and the funds are held until maturity. This reduces the interest rate risk compared to traditional bond funds. Even if interest rates decrease in the future, investors will continue to receive the locked-in yields. Additionally, the structure of TMFs works on decreasing residual maturity, making the returns more predictable.
• High credit quality: As per SEBI regulations, TMFs can only invest in Government Securities (G-Secs), State Development Loans (SDLs), and Public Sector Undertaking (PSU) bonds that mirror an underlying bond index. These investments enjoy sovereign or quasi-sovereign status, ensuring a high credit quality for TMFs.
• Accrued interest and compounding benefits: The bonds in TMF portfolios pay regular interest (coupons), which are reinvested in the fund. This allows investors to benefit from compounding and accrue interest over time.

Tax efficiency

Target Maturity Funds (TMFs) are considered a tax-efficient investment option, particularly when compared to traditional investment avenues.

TMFs are taxed differently depending on whether they are held for the short term or long term. If held for less than three years, short-term capital gains tax applies, and gains are taxed according to the investor's income tax slab rates. On the other hand, if TMFs are held for more than three years, long-term capital gains tax applies, and they are taxed at 20% after indexation benefits. This is more favourable than the 30% tax rate for long-term capital gains from traditional investments for investors in the highest tax bracket.

TMFs are also considered tax-efficient due to their ability to provide stable and predictable returns. The funds hold bonds until maturity, which means that investors can benefit from the power of compounding as the coupon payouts are reinvested in the fund. This helps to maximise returns and can result in better post-tax returns compared to other bond funds.

Additionally, TMFs are passively managed, meaning that fund managers do not actively trade securities. Instead, they aim to replicate the composition of the underlying index, which can result in lower fees and expenses for investors.

However, it is important to note that TMFs do not have a long track record of historical performance, which may make it challenging for investors to evaluate their potential returns accurately.

In summary, TMFs offer tax benefits due to their long-term capital gains tax treatment, stable and predictable returns, and passive management structure. These features make them a tax-efficient investment option, especially for those in higher tax brackets seeking stable, low-risk investments.

Are target maturity funds a good investment?

Target maturity funds (TMFs) are debt-oriented mutual fund schemes that track an underlying debt index, such as the Nifty SDL or the Nifty PSU Bond index. They are passively managed, meaning fund managers do not actively trade securities but instead replicate the composition of the underlying index. TMFs invest in debt securities like government bonds, public sector undertaking bonds, state development loans, and other bonds.

TMFs have a defined maturity date, which is aligned with the expiry date of the bonds in their portfolio. They carry a comparatively lower interest rate risk and provide more predictable and stable returns, making them suitable for investors seeking predictable returns like those offered by bank deposits.

TMFs are flexible and offer varying tenures. They work on decreasing residual maturity, meaning the maturity of the underlying bonds reduces over time. This results in a lower duration risk as the defined maturity date approaches, making the returns from this fund predictable.

TMFs are also not significantly impacted by interest rate movements as they primarily follow an accrual strategy, holding debt securities until maturity. They have less interest rate risk than traditional bond funds because they hold their bonds until maturity, which is advantageous in a rising interest rate scenario as it can otherwise decrease investment value.

Additionally, TMFs are tax-efficient compared to traditional investment avenues when invested for over three years. If held for less than three years, short-term capital gains are applied, treated similarly to traditional investments. TMFs also offer better liquidity than traditional investments.

However, there are some disadvantages to consider. TMFs lack a real performance history and track record, and if the fund is not held to maturity, your investment will be more affected by interest rate movements. The clearly defined investment universe also creates limited flexibility for fund managers as investments are restricted to specific maturities and/or specific constituents.

In conclusion, TMFs can be a good investment option for those seeking predictable returns and are willing to hold the funds until maturity. They offer flexibility, stable returns, and tax efficiency but come with the risk of limited historical data and the potential impact of interest rate movements if not held to maturity.

How to invest in target maturity funds

Target maturity funds are passive debt mutual fund schemes that track an underlying debt index, such as the Nifty SDL or the Nifty PSU Bond index. They are designed to reduce the interest rate risk that investors are exposed to and provide more predictable and stable returns.

These funds are a good option for those who are risk-averse and seek predictable returns in the medium to long term. They are also suitable for investors who prefer the predictability of returns offered by bank deposits.

• Register online on a trusted platform, such as the ABSLMF App or website.
• Click on the 'Mutual Fund' tab and select the 'Target Maturity Fund' you wish to invest in.
• Click on 'Invest Now'.
• Choose the amount and mode of investment, such as SIP (Systematic Investment Plan) or lump sum.
• Provide your Know Your Customer (KYC) information, including your PAN number and bank details, to complete the investment process.

It is important to note that target maturity funds are subject to market risks, and past performance does not guarantee future results. Investors should carefully consider their investment objectives, level of experience, and risk appetite before investing.

Frequently asked questions