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What is a Target Maturity Fund? By Vijay Patel, Director, Patel Associates

Currently, TMFs are mandated to invest in government securities, state development loans (SDLs) and PSU bonds. All these bonds or securities in the fund's portfolios are held to maturity. This ensures that the duration of the fund keeps shrinking with every passing year and thus investments are less prone to price fluctuations caused by interest rate changes, thereby adding an element of predictability in returns.

Vijay Patel, Director, Patel Associates
Vijay Patel, Director, Patel Associates

Target Maturity Fund (TMF) is an offering within the debt universe but is passive in nature. Such a fund aims to help investors navigate the risks associated with debt funds by aligning their portfolios with the maturity date of the fund. Since they track the bond index, such funds tend to have portfolios similar to that of the underlying bond index, and thus have maturities in line with the fund's stated maturity. As a result, the return generated too will be similar to that of the underlying index. 

 

Currently, TMFs are mandated to invest in government securities, state development loans (SDLs) and PSU bonds. All these bonds or securities in the fund's portfolios are held to maturity. This ensures that the duration of the fund keeps shrinking with every passing year and thus investments are less prone to price fluctuations caused by interest rate changes, thereby adding an element of predictability in returns.  

 

For risk-averse investors, who would opt for traditional products like Public Provident Fund (PPF), National Savings Certificates (NSCs) and banks' fixed deposits, TMFs could be a better proposition given its tax efficiency. Since securities in the portfolio of TMFs are held to maturity while all payments of interest during the holding period are reinvested in the fund, such funds act and operate in an accrual mode. But, TMFs are open-ended schemes, and thus offer greater liquidity to investors. Further, given the restricted investment universe, these investments typically carry lower credit default risk. 

 

Should you invest in TMFs? 

 

Given the recent credit risk defaults in some of the debt funds, investors had turned a bit wary about investing in debt mutual funds. However, that has not stopped fund houses from offering innovative solutions for investors. Risk is an inherent part of investments which cannot be removed completely. At best, necessary measures can be put in place to mitigate risk. The launch of TMF is one such attempt by the fund management industry to ensure investors have better investment experience. 

 

However, as is the case with other investment avenues, TMFs also have certain pros and cons which investors should consider before deciding to invest in them. Following are some of the points to consider. 

 

Benefits of Target Maturity Fund 

 

a) Liquidity, Flexibility and Predictability: Being open-ended, investors have the liberty to withdraw their units before maturity. As the duration risk keeps reducing with every passing year, a stated maturity date while holding units till maturity makes returns quite predictable in TMFs. 

 

b) Lower Credit Default Risk: With underlying securities invested in G-Secs, SDLs and PSU Bonds, the risk of default reduces considerably. So, risk averse investors may find this offering to their liking. 

 

c) Lower Interest Rate Risk: Since TMF follows accrual strategy, returns are protected from rising interest rate cycles. This is not the case with other debt funds wherein investment value declines with rising interest rates. 

d) Tax Efficiency: Indexation benefits make TMF more effective when it comes to post tax return compared with traditional investment options. 

 

Cons of Target Maturity Fund 

 

a) Lack of performance record: Since such offerings are relatively new and few, there is not much of long-term performance track record available. With time, these funds will have a track record to showcase. 

 

b) One must hold till maturity: Though unit holders are free to withdraw whenever they want, they could lose out on some gains as investments would be impacted by interest rate movements if not held to maturity. This will defeat the very purpose of investing in such a fund.  

 

c) Limited Securities: Currently, TMFs can invest only in designated securities which limit the investment universe. So, the room to manoeuvre is very limited given the restricted nature of these funds with pre-defined and stated maturity. 

 

In light of the pros and cons presented, investors with minimal risk appetite can consider investing in these with a medium to long-term investment horizon. Moreover, remember to align one’s investment horizon and fund maturity period. Finally, it is advisable that one should invest in TMF only if units can be held till maturity to reap optimal benefits. 

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