Target maturity funds, which had become the darling of investors in the past few years, have become the biggest casualty of the adverse tax changes for debt mutual funds introduced this fiscal.

TMFs have mopped up ₹155 crore from three offerings in FY24 compared with nearly ₹9,000 crore collected in FY23, data from Value Research show. From FY20-23, these funds garnered over ₹50,000 crore.

The AUM of these funds stood at ₹2.02 lakh crore as of December last year, of which Bharat Bond ETFs launched by Edelweiss Mutual Fund, contributed two-fifths of the assets. Assets of TMFs are expected to decline further as bonds mature and inflows shrink. “Such funds have seen a massive decline in interest from investors after the withdrawal of indexation benefit for pure fixed-income schemes, and the substantial return differential pre- and post-tax for investors in the higher tax bracket. Other asset classes for similar investment horizon offer higher expected returns both pre- and post-tax,” said Dwijendra Srivastava, Chief Investment Officer - Fixed Income, Sundaram Mutual Fund.

Longer maturity target maturity funds are also prone to mark to market volatility, making it unattractive for income seekers or short-term investors in an adverse move on interest rates, he added. Assume 7 per cent returns for a 3-year TMF. Under the earlier regime, post-tax returns would have fallen to 6.3 per cent, assuming a tax rate of 10 per cent. In the new regime, the returns will fall to below 5 per cent for those in the higher tax bracket.

Sold differently

Different investors were sold the product differently, said experts. The biggest pull came from the wealth management industry, which sold these as low-cost fixed-income allocation products to high net worth individuals. Retail investors were told that they could earn stable returns by holding to maturity or benefit from capital gains if they sold before maturity. Few corporate treasuries had taken the view that TMFs could be treated as held to maturity assets and need not be marked to market in their books —which became a big driver to invest in the product.

“TMFs are passive schemes and can’t alter the duration or tweak the portfolio to maximise returns in a diverse interest rate environment. These can only give straight-jacketed FD-type returns when held to maturity, which is no longer that attractive in an adverse tax environment,” said a debt fund manager.

Investors may gravitate to actively managed long-duration funds, which have increased their duration to 8-10 years recently, given the likelihood of interest rate cuts. TMFs, typically, do not come with that kind of duration. “TMFs were products for the slightly more informed investor. Some of those flows have moved to other vehicles such as private alternative investment credit funds,” said Dhaval Kapadia, Director & Head - Products, Ambit Wealth.

These products are not directly comparable but the yields are much higher in the range of 13-15 per cent and may be better for HNIs from a risk-reward point of view, he added. “The taxation change has been a dampener for TMFs and flows are unlikely to revive meaningfully going forward,” said Kapadia.

Experts, however, believe that investors can selectively look at longer-end TMFs when rates are high, since they are able to lock into high-carry returns for tenors that are generally not available in FD products.