Why invest in Target Maturity Funds

What are Target Maturity Funds?

Target maturity funds are open ended passive debt mutual fund schemes, which track an underlying bond index and have defined maturity dates. You will get the principal along with accrued interest on maturity of the fund. Target maturity funds (TMFs) can be in the form of Exchange Traded Funds (ETFs) or Index Fund. You need demat and trading accounts to invest in ETFs. If you do not have Demat account then, you can invest in Target Maturity Index Funds.

How Target Maturity Funds work?

• As per SEBI?s regulations, Target Maturity Funds can invest only in Government Securities (G-Secs), State Development Loans (SDLs) and Public Sector Undertaking (PSU bonds).


• Target Maturity Funds track an underlying bond index. These underlying bond indices have basket of bonds with a pre-defined maturity date.


• A target maturity fund will invest in exactly the same basket of bonds as the underlying index and hold them till maturity.


• The bonds will pay regular coupons (interest), which are re-invested in the same basket of bonds. On maturity you will get the face value of the bonds (principal amount) and the accrued interest.


• Since target maturity funds hold bonds till maturity, you can lock in current yields by holding the fund till maturity date.

Difference between Target Maturity Fund and Fixed Maturity Plans

Both fixed maturity plans (FMPs) and target maturity funds have fixed maturity dates; upon maturity both FMPs and target maturity funds will payout the maturity proceeds to the investors. However, there are some important differences between the two ? liquidity and credit quality.

FMPs are close ended funds; you cannot redeem units of FMPs before maturity date. Target maturity funds are open ended funds; you can redeem units of target maturity funds (subject to exit load structure) at prevailing Net Asset Values (NAVs). If you have invested in Target Maturity ETFs, then you can sell them in the stock exchange at any time at prevailing market price.

There is no restrictions with regards to the debt and money market instruments in which FMPs can invest as long as they mature with on or before the fixed maturity date. Target maturity funds, on the other hand, can invest only in G-Secs, SDLs and PSU bonds. G-Secs have sovereign guarantee; so there is no credit risk. SDLs are issued by State Governments. RBI guarantees interest and principal payments of SDLs; there is virtually no credit risk. The Government is the majority shareholder of the PSUs; the chances of a PSU bond defaulting is very low because it is backed by the Government. You can see that the credit quality of target maturity funds is very high ? virtually no credit risk.

Interest rate risk

Bond prices have an inverse relationship with interest rates. If interest rates rise, bond prices will fall and vice versa. The interest rate sensitivity of a bond is directly related to its maturity or duration. Longer the maturity or duration of a bond, higher is the interest rate risk. Target maturity funds are subject to interest rate risk. However, the interest rate risk of the target maturity fund reduces over time. Suppose, you invested in a 5 year bond and want to hold till maturity. After 1 year, the residual maturity of the bond will be 4 years, so the interest risk will be lower. After 2 years, the residual maturity of the bond will be 3 years, so the interest risk will be lower. As target maturity funds roll down the maturity curve, the interest rate risk reduces over time.

Why invest in target maturity funds?

• Simple structure and relatively high visibility of returns. If you hold a target maturity fund till maturity, your returns will be equal to the Yield to Maturity (YTM) adjusted for the fund expenses (TER).


• Since target maturity funds are passive schemes there total expense ratio (TERs) is much lower compared to actively managed schemes. If there are two funds (one active and one passive) with similar YTMs, the fund with lower TER will give higher returns.


• Very high credit quality, since target maturity funds only invest in G-Secs, SDLs and PSU bonds.


• High liquidity, since you can redeem units of target maturity index funds at any time with the AMC (subject to exit load structure) and sell units of target maturity ETFs in the stock exchanges at prevailing prices.


• Interest rate risk reduces over the investment tenure of the fund (as explained above).


• For investment tenures of 3 years plus, you can enjoy benefits of long term capital gains taxation. Long term capital gains in target maturity funds are taxed at only 20% after allowing for indexation benefits.


• Yields have risen considerably over the last 1 year or so. Yields of 4 to 7 year Government bonds are in the range of 7.2 ? 7.3% (source: worldgovernmentbonds.com). You can lock in the current yields over the maturity period by investing in target maturity funds.

Investors should consult with their financial advisors or mutual fund distributors if target maturity funds are suitable for their investment needs.