Stock market investors are by now used to index funds and Exchange Traded Funds (ETFs) which mimic a stock index. But there’s an emerging category of passive debt funds that can help meet many goals from buying a car or meeting the down payment for your home, to funding retirement or generating a regular income after it.

If held for three years plus, passive debt funds work as a more tax-efficient alternative to fixed deposits and small savings schemes. They offer anytime liquidity, while other debt options lock in money. They come at a much lower cost than active debt mutual funds. Here’s a low-down on them.

Diversified TMFs

In actively managed debt funds, the onus is on you to decide the horizon for which you’d like to invest and select the right category — overnight, ultra-short, short, medium, long term. Returns that you earn from such funds are hard to predict and can move up and down with market interest rates during your holding period.

But target maturity debt funds (TMFs) are launched with a very specific end-date. The fund manager buys and holds a diversified basket of securities, all of which mature on the fund’s maturity date. The interest earned accrues to the fund’s NAV. At maturity, the fund winds up and returns principal and accumulated interest (if you opt for the growth option).

This protects investors from interest rate risk. The yield-to-maturity at which you buy into a target maturity fund roughly corresponds to the returns you can expect to earn from it, with a small adjustment for the fund’s expenses. Expense ratios on TMFs are quite low at between 0.06 and 0.16% on direct plans and 0.06 and 0.50% for regular plans.

TMFs with a diversified portfolio typically track a custom-built index, but may not exactly mirror it. While some TMFs are constructed as ETFs, some are run as open-end funds. Edelweiss’ Bharat Bond ETF series, for example, invests in highly-rated PSU bonds, and is available for different maturity dates — 2023, 2025, 2030, 2031, 2032 and so on. Other fund houses run open-end TMFs that invest in a mix of government securities, PSU bonds and State Development Loans (SDLs) in different combinations. Some instances are Aditya Birla Sun Life SDL plus PSU Bond 2026 60:40 fund, SBI CPSE plus SDL Sep 2026 fund, Kotak Nifty SDL April 2027 fund and so on.

The fund name tells you both the portfolio composition and maturity date. Apart from the target date matching your goal, the key features to look is the latest YTM (yield-to-maturity) of the portfolio, expense ratio and mix of securities owned.

Gilt TMFs

A less complex variant of the diversified TMF is the gilt or SDL TMF, which only own one type of security (Central government securities or State Development Loans) with a common maturity date. Nippon India Nifty G-sec 2036, IDFC Gilt 2027, Kotak Nifty SDL April 2032, ICICI Pru Nifty SDL September 2027, HDFC Nifty G-sec July 2031 are some instances.

Usually, TMFs investing in Central g-secs own only one or two securities, while the SDL funds own a basket of bonds from different State governments. Your choice of gilt TMF should again depend on the timing of your goal, the current YTM of the fund and the expense ratio charged. To play it absolutely safe, gilt TMFs should be your choice while SDL TMFs offer you a shot at higher yields for slightly more risk. The expense ratios are usually lower than diversified TMFs.

Constant MFs

Constant maturity funds (MFs) do not have a specific end date, but always own securities of a certain maturity. So, a 10-year constant maturity fund would always own gilts with end-dates averaging out to 10 years. As the gilts in the portfolio mature, the fund acquires new ones with a similar 10-year term.

Entry, exit

Returns on constant maturity funds, unlike those on TMFs, depend on your entry and exit timing. When interest rates rise sharply in a short span, a 5 or 10 year constant maturity fund can suffer NAV losses, which are made up over time. Investors in such funds, therefore, need to time their entry to some extent or match their goals to the fund’s stated maturity and brace for volatile returns in the interim. Presently, these funds are available in 5-year and 10-year variants, with expense ratios of 0.50-0.70% on regular plans and 0.20-0.50% for direct plans.