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Are target maturity funds safer than other debt MFs?

Maulik Madhu | Updated on March 27, 2021

These products offer a certain degree of return visibility to those who stay invested until maturity

The credit ratings downgrade of IL&FS in 2018 followed by that of a few others such as DHFL and Yes Bank in 2019, impacted the NAVs of debt funds and brought home the point that these funds are not immune to credit risk. This year, impacted by a rise in bond yields, many longer duration debt funds have been reporting negative returns the last few months. In the past too, there have been such instances, bringing to the fore the interest rate risk involved here.

In this backdrop, target maturity funds whichoffer certainty of return (to a large extent) and a fair degree of safety are an attractive option for investors seeking an alternative to fixed income instruments such as bank fixed deposits. This is particularly so for those in the higher tax brackets. Many asset management companies such as Nippon India MF, Edelweiss MF and IDFC MF have launched open-ended target maturity debt funds recently.

The brass tacks

Target maturity funds have a defined maturity as indicated in the scheme name and passively invest in bonds of a similar maturity constituting the fund’s benchmark index. On maturity of the fund, investors are returned their investment proceeds (initial investment plus return).

These funds buy bonds such as corporate bonds, G-Secs (GOI bonds), SDLs (state government bonds) or a combination of these, in line with their benchmark index. For instance, the newly launched IDFC Gilt 2028 Index Fund will invest in the constituents of the CRISIL Gilt 2028 Index. Other debt funds, on the other hand, may sell bonds before they mature.

From a credit quality perspective, target maturity funds investing in G-Secs or SDLs, both of which enjoy sovereign (government) guarantee, carry no credit risk (risk of default) and are safe. Also, while funds investing in corporate bonds issued by public sector entities may rank a notch lower (AAA instead of sovereign rating), the government backing enjoyed by these entities lends comfort.

Return visibility

The biggest USP of target maturity funds is that they provide a certain degree of return visibility for those who stay invested until maturity. While the fund NAV gets impacted by interest rate changes in the interim, in the form of mark-to-market losses (or gains) on bonds in the portfolio, if you stay put until maturity, you will get the return indicated at the time of investing in the scheme.

For example, the indicative return (yield to maturity minus the expense ratio) for the recently launched Nippon India ETF Nifty SDL – 2026 Maturity and the IDFC Gilt 2028 Index Fund (direct plan) is 6.15-6.25 per cent and 6.24 per cent, respectively. The two funds have a tenure of around five and seven years, respectively.

Today, you can get up to 5.5 per cent, and 6.7 per cent per annum, respectively, on five-year public sector bank and Post Office (PO) fixed deposits. Floating rate savings bonds from the Central government with a seven-year lock-in offer 7.15 per cent per annum (paid half-yearly) currently. Interest income from these products is taxed at your income tax slab rate. Note that, the interest rate on PO deposits and the GOI bonds is reviewed quarterly and half-yearly, respectively. Capital gains made on target maturity funds (debt funds) held for over three years are taxed at 20 per cent with indexation benefit, making these funds an attractive post-tax option for those in the higher tax brackets.

Unlike in fixed maturity plans, in open-ended target maturity schemes, investors can enter as well as exit at any time. However, despite the inflows and outflows to and from these schemes, the possible impact on returns for those invested until maturity may be very small. According to Arun Sundaresan, Head-Product Management, Nippon Life India Asset Management, this will not impact returns, just like how equity open-ended index funds work. Interest rate movements during the tenure of the fund, however, may have a marginal impact, possibly 10-20 bps under a normal interest rate situation. “Sufficient liquidity in G-Secs ensures trades can be done seamlessly with very little impact cost,” adds Sirshendu Basu, Head-Products, IDFC AMC. Note that, this may, however, not be true for corporate bonds and SDLs to the same extent.

Stay put

Today, with economic growth recovering, the risk of inflation rising, and the gradual unwinding of the liquidity measures, no further rate cuts are expected from the RBI. As a result, you must be prepared for the possibility of capital loss (interest rate risk) as rates move up gradually, if you exit a target maturity fund prematurely. So, it’s best to choose a fund where the maturity broadly matches your investment horizon to park a portion of your investment surplus. For those in the lower tax brackets and not prepared to stay put long enough, shorter-tenure bank and PO fixed deposits may be a better alternative.

(This is a free article from the BusinessLine premium Portfolio segment. For more such content, please subscribe to The Hindu BusinessLine online.)

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Published on March 20, 2021
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