Your Money: Target maturity funds – A good bet; You can make the best of TMFs by aligning them with your goals

The six-member Monetary Policy Committee (MPC) kept its policy rates unchanged for the second consecutive time in June. The inflation trajectory is supporting the pause by the MPC. With this, most people think India is near its peak interest rates, at least for the near to medium term.

Can investors, especially those inclined towards fixed-income or debt securities, exploit such a situation to their advantage? Are there any investment products that meet the requirement of locking in interest rates at this level for stable and visible returns? This can be done by opting for passively managed debt funds. Currently, there are around 30 passively managed debt mutual fund schemes in the fixed-income space, including fund of funds, index funds and exchange-traded funds (ETFs). Most are ETFs. Most of these schemes are also open-ended target maturity funds (TMFs), which have pre-defined maturity and invest in bonds that mature on or before maturity of the scheme.

Underlying index

Since a fund manager is mandated to buy similar securities present in the underlying index, there is no scope for buying securities that may not deliver in line with the underlying index. The indices used for passive strategies consist of government securities, state development loans or bonds issued by top-rated public-sector enterprises with negligible chances of default. The total expense ratio charged in passive debt funds is relatively very low as compared to an active fund with similar maturity/duration, hence these savings on costs get added to the investors’ returns.

In case of TMFs, its portfolio yield is known beforehand. For investors willing to hold the units till maturity, there is a fair chance to pocket the portfolio yield after deducting expenses. This can be an advantage for conservative investors looking for alternatives to traditional fixed-income options like bank fixed deposits.

When an investor buys a traditional fixed-income instrument offering periodic interest payout, she has to look for avenues to reinvest receipts. In TMF, all interest receipts are deployed in line with a scheme’s investment objective. This results in efficient compounding of money culminating in a large corpus in the long term.

Associated risks

If you are a fixed-income investor, TMFs are a competitive product as compared to both traditional and modern debt investment avenues. Risks associated with any fixed-income asset are credit risk and interest rate risk. Since TMFs hold only quality debt papers, credit risk is greatly mitigated. If the fund is held till maturity, volatility in interest rates in the intermittent period till maturity does not matter to the investor.

Investors can make the best of TMFs if they can align them with their goals. Since TMFs are open ended funds, an investor can take entry and early exit (if need be) anytime. Passive management in fixed income, like TMFs, can be a low-cost, simple, predictable, efficient and a transparent avenue to park your money for good returns.

The writer is head of ETF, Nippon India Mutual Fund