Summary
This blog explains the meaning of target maturity funds, which invest in bonds with a predefined maturity date while tracking a particular market index. The rate of interest highly influences the returns generated on these funds.A rise in interest rate may result in a decline in the net asset value of the funds.Â
Target Maturity Funds
Target maturity funds are mutual funds that invest in bond securities by passively tracking a specific bond index and have a predetermined maturity. They mostly invest in fixed-income securities such as government securities (G-secs), State Development Loans (SDLs), and Public Sector Undertaking (PSU) bonds. These funds are held till maturity. Upon maturity, investors receive the proceeds from the underlying securities, which include the principal amount and the income earned over the investment period, considering the fund’s expenses and market-related factors.Â
Key Features of Target Maturity Funds
The key features of target maturity funds are mentioned below.
- Predetermined maturity: Target maturity funds consist of a fixed maturity date. The underlying bonds are chosen based on their maturity profiles to match the fund’s maturity date.Â
- Passive ‘buy-and-hold’ strategy: Target maturity funds follow an underlying bond index, making it a passive strategy, while holding the securities to maturity.
- High-quality bond: Target Maturity Funds generally invest in government securities and other highly rated debt instruments, which may help reduce credit risk.Â
- Reduced interest rate risk: They hold the investment to maturity, reducing the risk of market volatility because of fluctuating interest rates.
- Cost efficiency: Since they track an index and do not require active participation in constant re-evaluation, this reduces the fund’s expense ratio.
How Target Maturity Funds Work
The target maturity fund is a fund where investors are only required to select the fund that matures close to the year they wish to withdraw their investment. The fund managers manage these funds. The managers invest in the funds based on an underlying index and as per the scheme mandate and hold them till maturity. The returns of these funds are generally driven by interest earned on bonds, changes in bond valuations, and the reinvestment of coupon proceeds over time.
These funds have a predefined maturity date, generally reflected in the fund’s name, allowing investors to align their investments with specific financial goals and time horizons. It chooses the glided path, which reduces the risk of volatility over time. As the securities are held till maturity, the funds get enough time to recover from any market declines. The fund managers balance the securities accordingly so that they do not concentrate on a single asset or market.
Role of Bond Yields and Interest Rates
Bond yields and interest rates play a significant role in determining the overall performance of Target Maturity Funds, as they directly influence bond prices and portfolio returns. The bond yield is the actual return earned by investors on the investment. However, any change in the interest rate changes the net asset value (NAV) of the funds.Â
When interest rates rise, newly issued bonds with higher yields become more attractive to investors than existing bonds with lower coupon rates, which leads to a decline in the market value of older bonds. On the other hand, a decrease in interest rates can increase the attractiveness of existing bonds with higher coupon rates, leading to a rise in their market prices. Therefore, interest rates and bond yields are the key factors influencing the performance of Target Maturity Funds, as they directly affect the prices of the underlying bonds and their overall returns.
Benefits of Investing in Target Maturity Funds
Target Maturity Funds offer various benefits to investors, some of which are highlighted below.
Ideal for Long-Term Planning
Investors can choose a Target Maturity Fund whose maturity date aligns with their expected withdrawal timeline. Holding the investment until maturity can help reduce the impact of interest rate fluctuations and short-term market volatility, allowing investors to align the fund’s intended investment outcome.
Low Expense and Transparency
Since these investments track a predefined market index, they eliminate the costs associated with consistent evaluation of the market and provide transparency into the portfolio composition. This allows investors to track the securities and the returns generated on them.
Risks and Limitations You Should Know
The risks and limitations included in target maturity funds are given below.
- Interest rate reduction: The bond value and interest rate are inversely related. An increase in the interest rate may lead to a reduction in the net asset value (NAV) of the fund.Â
- Loss of long-term compounding: If the investments are withdrawn before maturity, they fail to earn the complete yield on the bond, by interrupting the roll-down strategy.
- Liquidity risk: Since the fund tracks a specific market index, any change in the market conditions may reduce the ease of buying or selling the investments.
What Happens If You Exit Early?
Target maturity funds are generally designed to be held till maturity. Early withdrawal of the investment may affect the overall expected return on it. The redemption value of the fund depends on the market conditions and the net asset value of the fund on that date. If the rate of interest increases, the bond prices may fall, leading to a low net asset value of the fund. This may result in capital losses while redeeming the fund.
Target Maturity Funds vs Other Debt Options
The comparison between target maturity funds and other debt options is given below.
TMF vs Fixed Deposits
Here is the comparison of target mutual funds and fixed deposit
| Basis | Target maturity funds | Fixed deposits |
| Investment type | Debt mutual fund | Bank deposit |
| Liquidity | Buying or selling can be practiced in the exchange market or through fund houses | Withdrawal before maturity generally attracts penalties |
| Returns | Market-linked yield | Predetermined and fixed returns |
| Risk | Low to moderate | Generally low |
TMF vs Other Debt Funds
| Basis | Target maturity funds | Active mutual funds |
| Investment type | Passive, market index-tracking fund | Actively managed fund |
| Maturity date | Fixed and predetermined | Generally no fixed maturity date |
| Expense ratio | Low; because the fund follows a particular index | High; because the funds are actively bought, sold, or held by the fund managers |
| Objective | Match the performance with specific index | Generate returns through active management |
Who Should Invest & Portfolio Strategy
Target maturity funds are designed to meet the needs of certain investors. They are given below.
- Investors seeking to invest in the fixed-income debt market.
- Investors seeking to invest for a specific period of time.
- Investors who want to invest in relatively safe securities and easily track the portfolio by following a specific market index.
The portfolio strategies to invest in target maturity funds are given below.
- Goal-alignment: Investors must select a fund with a maturity date that satisfies their financial goals. If the funds are held till maturity, the fund gets enough time to recover from any market corrections.
- Debt holding: These funds mostly focus on reducing the credit risk by investing in government securities, state development loans, etc. This helps the fund create a diversified fixed-income portfolio.
- Laddering strategy: Instead of concentrating on a single target maturity fund, investors must choose multiple funds with different maturity dates. This helps to improve the cash flow and overall liquidity of the funds.
Real-World Example: How TMFs Deliver Returns
Let’s understand the TMF returns with the help of an example.
An investor, Mr C, invests ₹10 lakh in SBI Nifty G-Sec Jul 2031 Index Fund, a target maturity index fund expected to mature on 31 July 2031. At the time of investment, assume the portfolio yield is around 7.2% per annum. The fund primarily invests in government securities forming part of the Nifty G-Sec Jul 2031 Index.
If Mr C holds the fund till maturity, his return may be broadly close to the portfolio yield available at the time of investment, after accounting for fund expenses, tracking error and reinvestment risk. The return is not guaranteed, and 7.2% should not be described as a fixed coupon paid to the investor.
During the holding period, coupon income received by the fund is reinvested in the portfolio. This reinvestment, along with the gradual maturity of the underlying securities, helps reduce the impact of interim interest rate movements for investors who stay invested till maturity. However, the NAV can still move before maturity if interest rates change.
Final Thoughts
Target maturity fund is a mutual fund that invests in bond securities by tracking a particular market index that has a predetermined maturity period. These funds provide greater transparency, cost efficiency through lower expense ratios, and suitability for long-term financial planning. These funds are suitable for investors seeking exposure to the debt market and fixed-income securities, and a fixed maturity date.
The return on these funds is inversely related to the market interest rate. Higher interest rates generally make older bonds less attractive, leading to lower bond prices and a potential decline in the fund’s NAV. While, falling interest rates may increase bond prices and boost the fund’s NAV.
However, target maturity funds are also market-linked, so investors must identify their investment objective and understand the underlying portfolio before investing.
FAQs
Target Maturity Funds and Fixed Deposits serve different purposes. FDs generally offer greater certainty because the returns are fixed at the time of investment. TMFs invest in bonds and are subject to market fluctuations, although they typically invest in high-quality debt securities.
No, Target Maturity Funds do not guarantee returns. Their performance depends on factors such as bond yields, interest rate movements, expenses, and the performance of the underlying securities.
If you redeem your investment before the fund’s maturity date, your returns will depend on the prevailing Net Asset Value (NAV). Changes in interest rates and bond prices may result in gains or losses compared to your initial investment.
Yes, Target Maturity Funds can be suitable for beginners who seek exposure to debt markets through a relatively simple and transparent investment structure. However, investors should understand the associated risks and investment objectives before investing.
Capital gains from Target Maturity Funds are taxed according to the prevailing tax rules applicable to debt mutual funds in India. Investors should refer to the latest tax regulations or consult a tax professional for updated information.
Yes, many Target Maturity Funds allow investments through a Systematic Investment Plan (SIP), enabling investors to invest regularly in smaller amounts instead of making a lump-sum investment.
