What are the different types of target maturity funds and why should you invest in them?
If you want to generate higher returns compared to bank fixed deposits and are simultaneously concerned about capital protection, then a target maturity fund (TMF) may be a suitable option. This is because the fund is a mutual debt fund that offers guaranteed returns and, unlike equity funds, is a viable and safer option. So consider this debt fund option if you have a short- or mid-term investment goal. Please read below to learn more about TMFs and their distinct types.
What are TMFs and their distinct types?
They are debt mutual funds, which endow a fixed amount at maturity. They may be ETFs (exchange-traded funds), index funds, or FoFs (funds of funds). When issued through ETFs, they may be traded in markets. These debt funds can invest in SDLs (state development loans), corporate bonds, G-secs (government securities), or a blend. TMFs’ fund managers tend to replicate the underlying debt index. The credit risk linked with such debt schemes is low as they invest in AAA-rated and sovereign issuers whose default chance is negligible.
How do TMFs work?
As mentioned above, target maturity funds invest in SDLs, PSU bonds, and G-secs that mirror the underlying bond index. SDLs enjoy quasi-sovereign status as the interest and principal amount come from the State Government’s budget. G-secs and PSUs also enjoy sovereign status. So, the credit quality in the case of TMFs is high.
Why should you consider investing in them?
Open-ended debt funds
TMFs are open-ended funds. You can liquidate your investments anytime. This means the TMF schemes are liquid, and you can exit the scheme easily. However, investing in the tax implications of capital gains is recommended when leaving the fund.
Flexibility
TMFs are flexible and come with different tenures of identifying investments that generate high yields at a specific time. The structure of such funds is to lower the residual maturity. As time passes, the underlying bonds’ maturity continues to fall. Thus, the duration risk also continues to decline. This makes it simple to predict the returns.
Rate of interest movements
As TMFs invest majorly in debt instruments until maturity, their interest returns are insulated from the effect of rising interest rates. These debt funds are less susceptible to interest rate risk than standard bond funds.
Tax efficiency
TMFs provide stable and predictable returns. Additionally, they are even more tax-efficient than traditional instruments. Target mutual funds are taxable at 20 percent post-indexation when the holding period is over three years. If the holding period is below three years, short-term gains on investments are added to your taxable income and taxed according to your income tax slab.
Ending note
TMFs generate predictable returns and are suitable for meeting your short-term to mid-term financial goals. Thus, you can consider investing in such funds if you have a similar investment term horizon.
