Target maturity funds (TMFs) went off the radar for most investors after the unfavourable tax change for the debt funds category since April 1, 2023. TMFs earlier enjoyed long-term capital gains benefits with indexation if held for more than three years. Now, gains on debt funds including TMFs are taxed at slab rates irrespective of the period of holding. However, TMFs are still an attractive option for investors today due to three reasons :
At the time of launch - which were dime a dozen in 2022, TMFs were projected as useful for investors to lock into assured returns if the tenure of the fund matched with an upcoming goal. And these launches were timed to coincide with the highs in bond yields.
However, TMF investments find utility today too. Consensus view is that the rate hike cycle is done with and we are on a prolonged pause before cuts can begin. Locking into the yields today (for a suitable tenure) is a prudent approach to capitalise on good returns on the debt side, which may begin to soften in the near to medium term. As essentially TMFs promise the indicated yield at the time of the entry if investor stays put till the maturity of the fund, existing funds which are open-ended can be used to take tactical exposure now to make the best of yields on offer today.
Tenor-wise indicative yields from CCIL show that over short, long and very long timeframes, G-Sec yields are in the range of 6.9–7.3 per cent. However, the CCIL SDL Index (SDL – State Development Loans) yield stands much higher at 7.6 per cent. Latest data from ICRA Analytics (January 23, 2024) shows that the spreads between 10-year G-Sec and 10-year SDL yields are at 45-50 basis points (bps) currently, the highest in more than two years.
Latest data from CRISIL (Rate View, January 2024) puts the spread between the 10-year AAA PSU bonds and the 10-year G-Sec at 46 bps. Due to higher supply now, spreads of AAA PSU bonds over G-Secs, especially at the shorter end, are at attractive levels, says Rajeev Radhakrishnan, CIO, Fixed Income, SBI Mutual Fund.
To cash in on this, TMFs which invest exclusively in SDL/PSU bonds or as a combination with G-Secs may be good options to consider. Data from Value Research shows many TMFs which invest exclusively in SDLs/PSU bonds or a combination of G-Secs/SDL/ PSU Bonds sporting Yield to Maturity (YTM) at 7.6-7.77 per cent. The maturity of these funds ranges from as early as 2025 to as late as 2033.
Diversification from FDs
With the removal of the indexation benefit and the distinction between short/long-term holdings gone, taxation of gains in TMFs is now on par with fixed deposits. Since investors entering today have to stay put till maturity to realise today’s YTM, the product structure also becomes similar to fixed deposits.
While the remaining tenure of existing TMFs is not strictly comparable to the tenures available on FDs, TMFs discussed above offer similar or slightly higher returns (net of expense ratio, which averages 0.17 per cent for direct plans) compared to bank and post-office FDs. Rates on post office time deposits across 1-5 years stand at 6.9 to 7.5 per cent. Key public and private sector banks offer 6-7.25 per cent across tenures, though at the shorter end of 1-2 years where liquidity is tight, some banks offer higher rates.
Small finance banks may offer higher rates across tenures too. Of course, higher rated NCD offers (primary market) or NBFC deposits may give slightly higher returns, but the risk aspect is not comparable. Net-net, for those investors looking to diversify from FDs, these TMFs provide an alternative today.
Safety and ease
As discussed above, TMFs, which invest exclusively in G-Secs, SDL or AAA PSU bonds, sport a credit risk profile comparable to bank and post office deposits. Hence, even after the taxation change, they suit investors with a low risk appetite. Whichever be the fund you choose, ease of investing, either directly through the fund house’s website or through online platforms, is an advantage.
In scouting for the best FDs to invest in, one may often have to visit the bank branch or even open an SB account if you don’t have a pre-existing relationship with that bank. Small finance bank branches are few and far between too. Online options are a limitation with post offices. Another advantage is that in TMFs, the gains are offered to tax only on maturity, while in FDs, the interest is usually taxed on an accrual basis.
Investors can direct their TMF investments to coincide with specific life goals for greater certainty.