Target maturity funds - What are they their benefits and downsides

Bond markets can help investors diversify beyond equities. Particularly, when the economic outlook seems uncertain and volatility in the stock markets is something you want to avoid. In this context, debt mutual funds are an accessible and simple route to invest in bonds. There are several types of debt funds, and all of them offer unique risk-return profiles and features. One type of bond debt funds is target maturity fund, and despite its beneficial features, not many investors know about it. Read on to find out more about target maturity funds.

What are target maturity funds?

Target maturity funds are passively managed open-ended debt mutual funds that may prove to be a good addition to your portfolio. These funds aim to track and replicate the performance of a specific index, and they allow you to invest in the bond market in a potentially safe and diversified manner. You can think of them as the debt fund equivalent of equity index funds. However, instead of tracking a stock market index, target maturity funds track a bond index.

Target maturity funds have a defined maturity date, and on this date, investors receive their principal and all the accrued interest payments. These funds allow you to lock in the current interest rate, and therefore, even if the interest rates fall at a later date, your investment yields will not be affected. This is just one of the many benefits of target maturity funds. Let’s take a look at the others.

Benefits of target maturity funds

Here are some of the benefits of target maturity debt funds:

• High-quality underlying securities

Target maturity debt funds invest primarily in high-quality securities such as government securities, State Development Loans (SDLs), and PSU bonds that mirror the chosen benchmark index. All these types of bonds carry minimal to no credit risk.

Government bonds are backed by the sovereign guarantee of the Indian government, and SDLs offer a somewhat similar level of security because the principal and interest payments are allotted from the budget of the state government. PSU bonds are also considered safe because they are issued by government undertakings. Hence, the level of risk of target maturity funds is low because the credit quality of the underlying securities is rather high.

• Open-ended schemes

At first glance, target maturity funds may appear to be similar to fixed maturity plans. However, the difference is that the former are open-ended schemes, whereas the latter are closed-ended schemes. For this reason, in fixed maturity plans, you cannot sell or redeem your units at any time you wish, meaning that they offer poor liquidity.

By contrast, target maturity schemes are open-ended, and you can sell your holdings in such schemes at any point in time, perhaps because you wish to move your money to another investment option or you need the money for an emergency. Thus, target maturity schemes offer high liquidity.

• Low-cost debt investments

Target maturity funds are passively managed mutual funds. They track an underlying index, and their aim is to mirror that index’s performance. Hence, their portfolio holdings and rebalancing strategies are based on the underlying index, and the fund manager does not have to make any active decisions in terms of portfolio composition.

For this reason, target maturity funds have low expense ratios compared to actively managed debt funds, which makes them a low-cost investment. The expense ratios of direct plans tend to be 0.10–0.20% while those of regular plans are usually 0.20–0.50%.

• Interest payments are reinvested

Unlike other bond funds, target maturity funds hold the underlying securities until maturity. This means that you benefit from all the interest payments over the maturity period in which the fund reinvests.

Hence, you are benefiting not just from the accrued interest payments you receive at the maturity date but also from compounding.

Downsides of target maturity funds

One of the primary downsides of these funds is the lack of flexibility. Since the fund needs to hold its underlying securities until their maturity dates, the fund manager cannot adjust the fund’s portfolio to capitalize on changing market conditions.
Another downside is that if you wish to redeem your units before the maturity date, you have may to sell at a discount. Capital protection is guaranteed only if you hold the investment until its maturity date when the principal and interest are paid to you.

Final words

If you are looking to add exposure to high-yield bonds of good credit quality to your portfolio, target maturity funds can be a good option. The cost of investment is low because these funds are passively managed. You would do well to assess your risk tolerance, financial goals, and investment tenure before making any investment decisions.

Source: Axismf Research

Note: Views and opinions contained herein are for information purposes only and should not be construed as investment advice/ recommendation to any party or solicitation to buy, sale or hold any security or to adopt any investment strategy. It does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. The recipient should exercise due caution and/ or seek professional advice before making any decision or entering into any financial obligation based on information, statement or opinion which is expressed herein.

Statutory Disclaimer: Axis Mutual Fund has been established as a Trust under the Indian Trusts Act, 1882, sponsored by Axis Bank Ltd. (liability restricted to Rs. 1 Lakh). Trustee: Axis Mutual Fund Trustee Ltd. Investment Manager: Axis Asset Management Co. Ltd. (the AMC). Risk Factors: Axis Bank Limited is not liable or responsible for any loss or shortfall resulting from the operation of the scheme. No representation or warranty is made as to the accuracy, completeness or fairness of the information and opinions contained herein. The AMC reserves the right to make modifications and alterations to this statement as may be required from time to time.

Past performance may or may not be sustained in future.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.