Target maturity funds: Here’s all you need to know

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The range of funds possible in the mutual fund space is defined by SEBI, on the contours of what the funds can do. However, within the definitions, new ideas do emerge, e.g. Index Funds, ETFs (passively managed funds) or theme or sector funds (actively managed funds). New fund ideas add to the choice available to investors. There may be an element of confusion on which of the multifarious funds are suitable for you, but that is where the role of the adviser / distributor comes into play. Today we will discuss one of the emerging ideas in debt mutual funds, that of target maturity funds (TMFs).

To explain the concept of TMFs, to relate, let us start with a concept known to most people, that of fixed maturity plans (FMPs). There is a defined date on which the fund will mature, and on maturity investors will get back their money, along with the returns. The advantage of FMPs is that the investor is “locking-in” returns available in debt instruments when the product is floated. Locking-in means the bonds (or other debt instruments) that are purchased in the portfolio match the maturity date of the FMP. Hence, from start date to finish date, the movement of interest rates in the market, up or down, does not matter. However, the advantage of FMPs ends there. If you require money prior to maturity of the fund, that is a question mark. These are listed at the stock exchange, but there is no liquidity. If you want to sell your units of the FMP you are holding, you may not find a buyer. That means, from start to finish, in an FMP, you are effectively giving up your liquidity. The other issue is, when FMPs were in vogue, the usual tenure of the product used to be 3 years. That limited the choice for investors, due to lack of other maturity horizons.

Things investors need to know

With this backdrop, we now come to the concept of TMFs. In TMFs, there is a defined maturity date, on which the fund will mature and money will flow back to investors. The returns are being locked in. There are multiple maturity dates, in products floated by various AMCs, hence you can take you pick as per your cash flow requirement. Not only that, if you require money prior to maturity, liquidity is available. There are two formats in which TMFs are structured. One is called Index Fund, where the TMF follows the designated index and you can purchase from and sell to the AMC in the usual course. This is not there in case of FMPs. The other format for TMFs is ETFs where you can transact at the Stock Exchange where the fund is listed, but cannot purchase from or sell to the AMC. On this parameter, Index Fund is better than the ETF format. Moreover, for transacting in ETFs, you require a demat account and a trading account with a stock broker. The portfolio credit quality of TMFs is top notch. The best possible credit quality is that of Government Securities. Of similar quality, are securities issued by State Governments known as State Development Loans (SDLs). Next to this, there are bonds issued by PSUs that are rated AAA, which is the highest credit rating.

NFOs

Recently, two new fund offers (NFOs) of TMFs have been floated. ICICI Prudential AMC has come out with PSU Bond plus SDL 40:60 Index Fund – Sep 2027. Portfolio comprises 40% AAA rated PSUs and 60% SDLs and it matures in September 2027. Aditya Birla Sun Life Nifty SDL Plus PSU Bond Sep 2026 60:40 Index Fund has a similar portfolio construct. The portfolio yield-to-maturity (YTM), which is an indication of the interest accruing in the portfolio, is 6.28% for the ICICI fund. This is prior to the recurring expenses that will be charged to the fund. Any which way, given the good portfolio credit quality of TMFs and the level of fixed deposit rates at leading banks, the YTM level is attractive. Apart from these two, there are, in ETF format, Bharat Bond ETFs of various maturities: April 2023, April 2025, April 2030 and April 2031. Portfolios of Bharat Bond Funds comprise AAA rated PSU bonds.

Not to forget, the tax efficiency in any debt fund over a holding period of three years, by virtue of inflation indexation. The net capital gains after the indexed-up purchase cost is subject to tax at 20%. Effectively, by virtue of indexation, the tax rate becomes negligible. You need not hold till maturity for indexation benefit, it has to be held for three years or more.

(The writer is a corporate trainer and author. Views expressed are personal)