Target Maturity Funds offer safety, liquidity, tax-efficiency


Investor curiosity and interest in debt mutual funds has certainly been on the rise. However, investors still do not have a complete understanding of these funds and the additional benefits they can offer. Given that interest rates are on a gradual rise, investors would find it reassuring to have some stability in their portfolio and look to invest in avenues that can offer such stability. While traditional investment avenues offer stable returns, they do not readjust with the changing interest rate scenarios on a real time basis. This is where I believe target maturity funds (TMFs) can be a good fit to an investor’s portfolio.

TMFs are passively managed open-ended debt mutual funds that track a benchmark bond index with a pre-defined maturity date. To understand better, you can compare these funds to traditional investment avenues such as fixed deposits (FDs). To begin with, while in an FD the money is parked with the bank, TMFs mostly invest in high-quality fixed income instruments such as government securities, state development loans, PSU bonds, among others. Further, like a FD has a pre-decided investment tenure, say, 3 or 5 years, these funds also have a predefined maturity (which is aligned with that of the underlying index) post which the investor will get their investment back with the gains over the tenure.

TMFs are open-ended, which means that investors can enter and exit the scheme at any time, unlike FDs where the money is locked in for a definitive period. This makes TMFs a more liquid investment as compared to traditional ones. Further, TMFs aim to provide returns that closely correspond to the total returns of the underlying index. Bonds in TMFs are held till maturity which reduces the interest rate risk if the investor chooses to stay invested till the maturity of the fund.

We can understand this better with the help of an illustration below where the YTM has been assumed at 7.0% and modified duration at 3.5 years. This can give investors an insight into the impact on the holding period returns of the fund when there is a change in interest rates.

Interest rate
change (in bps)
Holding Period Returns
After 1 Year After 2 Years After 3 years Hold to Maturity (HTM)
Hike 50 bps 5.75% 6.25% 6.75% 7.00%
Cut by 50 bps 8.25% 7.75% 7.25% 7.00%

i)The HTM has been assumed that of the YTM of 7.0%. ii) The scenarios are based on hypothetical assumption of changes in interest rates and theoretical movements in bond yields. iii) Simulation is assumed pre-expenses. iv) This should not be taken as an indication of the returns that can be generated by the fund and the securities bought by the fund may or may not be held till their respective maturities. v) The interest rate move is assumed at the end of year. vii) Past performance may or may not be sustained in future.

As seen from the illustration, TMFs, by aligning their portfolio with the maturity date of the index, can help investors navigate the interest rate risk associated with uncertain interest rate environment if they stay invested for the duration of the fund. An investor investing in TMFs should stay invested in the fund for a minimum period of one year as the investment made for a short duration can lead to negative returns as well.

Additionally, TMFs offer tax efficient returns as compared to traditional investment avenues. The long-term capital gains tax on investments held for more than 3 years is 20% post indexation (adjusting the initial investment for inflation*) as compared to 30% in case of traditional investment avenues (for investors falling in the highest tax bracket). Thus, TMFs can be a good fit for both retail and institutional investor portfolios as it meets the essential investment requirements of safety, liquidity, and tax efficiency. However, it is pertinent to note that we are in a potentially rising interest rate scenario and investors should not invest in these funds for a short period of time, or if they have an investment horizon quite different from that of the maturity of the fund.

(The author is the Deputy Managing Director & Chief Business Officer in SBI Mutual Fund)

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