India is a country of savers, and many of us prefer fixed return instruments like fixed deposits and guaranteed return products. The proof lies in the scores of accounts at post offices, banks, and other small savings schemes.
Quite recently, many Indians have come to realise the advantage of debt mutual funds. They are better than bank deposit type of debt instruments because debt mutual funds can offer better returns and tax-efficient gains. So, many have started to invest in debt funds.
Recently, three target maturity debt funds were launched, which are like a breath of fresh air for debt fund investors.
What are target maturity funds?
Target maturity funds are debt funds with a specific maturity date, which is decided as per the expiry date of the bonds in its portfolio. These debt funds carry a lower interest rate risk and offer more predictive and stable returns, suitable for investors who like bank deposits.
Advantages of target maturity funds
Based on the strategy followed by target maturity funds, there are potential advantages and disadvantages of investing in them.
Below are the advantages of investing in target maturity funds:
Flexibility: Target maturity funds are flexible and come in varying tenures. The structure of target maturity funds is based on decreasing residual maturity. So, with each passing year, the maturity of the underlying bonds reduces. Thus, the duration risk decreases with the approach of the maturity date, making the returns from the fund predictable.
No impact due to interest rate movements: Target maturity funds primarily follow an accrual strategy. They hold debt security until maturity, so even if the interest rate rises, the fund’s returns stay protected instead of undergoing a decrease in investment value.
Tax efficiency: Along with bringing visibility and stability in returns, target maturity funds are also tax-efficient compared to traditional investment avenues when invested for more than three years. When investments are held for less than three years, short-term capital gains are applicable.
Liquidity: Target maturity funds offer better liquidity than fixed maturity plans. You can sell or redeem units of target maturity exchange-traded funds or index funds at any time on stock exchanges or with asset management companies.
Disadvantages of target maturity funds
Let us also look at the disadvantages of target maturity funds:
No track record: There is no real performance history or track record of target maturity funds. Also, you have to hold the fund till maturity or your investment will be even more affected by the interest rate movements.
Restrictions for fund managers: A clearly-defined investment like specific maturity and constituents leaves little flexibility to fund managers.
Tracking error: A high tracking error means a more significant variance between the fund and the benchmark’s returns, which can worry investors.
Should you invest in the target maturity funds?
At a time when inflation is rising, and no further rate cuts are expected from the RBI, it is best to choose a fund whose maturity matches your investment horizon for investing. So, if you want to park your funds for the medium to long term, then target mutual funds can be a good option. However, invest in debt funds of this type only if you can hold them until maturity.