Why target maturity funds are gaining popularity

In the last three years, the Target Maturity Funds (TMF) have gained exponential popularity and growth. As of Nov 2022, there was 52 mutual funds product in India with combined asset under management of Rs. 1,32,140 Cr. This growth is phenomenal considering the category was non-existent a few years back. It has helped in roping not only institutional investors but also HNIs and retail investors towards taking exposure in the Indian debt market through index funds and ETFs.

Passive Target Maturity Funds (read Index funds and ETFs) aims to replicate the composition of the underlying debt index and have a specified maturity date. These funds differentiate themselves from regular debt mutual funds by having a fixed maturity date, where maturity and duration roll down over the life of the fund and paying off investors upon the maturity of the fund, making potential returns visible to the investor at the time of investment.

Several factors have helped in the wide acceptance of TMF. One of the most important is the visibility of the underlying portfolio and potential yield upon maturity. Since TMF is a passive product, the investor can assess his/her comfort level with the underlying portfolio created based on defined rules. This has become critical post-credit default and winding up of certain debt schemes in the country. The investor can be reasonably assured that a TMF tracking an index comprising of AAA Public Sector Undertaking bonds cannot invest in bonds of AAA-rated HFC or NBFC or invest in AA+ rated securities etc.

TMFs also provide yield visibility to the investor if they remain invested till the maturity of the fund. This also leads to it being compared to traditional fixed-income instruments such as bank fixed deposits etc. However, they score over your traditional fixed income avenue on two fronts: first, yields in the bond markets are relatively quick to reflect the market condition and compensate investors accordingly, whereas the interest rate on fixed deposit may not increase adequately within stipulated time and second, an investor can get the benefit of indexation thereby lowering his/her tax liability by investing in Target Maturity Fund (TMF) vis-à-vis traditional fixed income avenue.

Similarly, when compared to a Fixed Maturity Plan (FMP) where the score is that the Investor has the option to subscribe or redeem anytime during the lifecycle of a target maturity fund which he/she cannot do in the case of FMP and the case of FD’s. As opposed to investing in individual bonds and tax-free bonds, the retail investor may find TMF more accessible and investable in a smaller denomination which may not be the case while investing in individual bonds and tax-free bonds. Being passive products in nature the TMF are a relatively low-cost product. The Total Expense Ratio (TER) of TMF products ranges up to 50 bps on the regular side whereas actively managed debt product charge TER up to 2% on the regular side.

Notwithstanding the various advantages TMF has to offer, an investor should note that the Target Maturity Fund (TMF) scheme is not principal protection or guaranteed return scheme. If TMF invests in non-sovereign securities then it is exposed to credit risk, theoretically. Further, if an investor sells or redeems his/her units before the maturity of the scheme then his/her return may be higher or lower than the indicated Yield to Maturity (YTM) at the time of investment i.e. he/she is exposed to interest rate risk, if not held till maturity. Lastly, an investor should note that YTM at the time of deployment of the fund is a relevant indicator of potential return, further, some yield leakage due to expense ratio, inflows and outflows from the fund and corresponding yield movement, etc. shall be kept in mind before investing in the TMF Product.

To conclude, despite some challenges inherent with TMF, it continues to be a relatively superior product and probably offer the investor with potential to earn more than what they earn on their parking of funds in traditional investment avenue such as fixed deposit, etc. Investors should understand the broad framework of the index and assess his/her risk appetite before making any investment decision. (The Author is Head – ETF Products, Mirae Asset Investment Managers)