Target Maturity Funds are passive debt funds which invest in government and PSU bonds; hence, they offer returns with minimal risk. However, fluctuating interest rates could impact these funds.
Target Maturity Funds (TMFs) are open-ended passive debt funds that invest in government bonds, public sector undertaking (PSU) bonds, and state development loans. They aim to replicate the makeup of an underlying index such as the NIFTY or NIFTY PSU Bond, NIFTY SDL (State Development Loan), etc. However, instead of attempting to outperform the index, the goal is to produce a return identical to it.
The goal of the investor planning to invest in a target maturity fund should be to generate nominal returns and risks compared to passive equity funds. Although every fund scheme has a pre-determined maturity time identical to the bonds it has invested in, say around 6–8 years, you can also find funds with an even higher maturity period.
Bond Maturity
When the maturity of the underlying bonds arrives, the investor is paid with the NAV at which the underlying bonds mature. If the maturity date of the bonds gets changed, then the Target maturity fund’s date of maturity will also change.
Advantages of Target Maturity Funds
Open-ended
These are open-ended funds, which essentially means you have complete control over when you enter and withdraw from the fund. However, you must consider the tax implications associated with the fund redemption.
Tax Benefits
One of the main advantages of TMFs and other debt mutual funds over traditional debt or bond instruments is this. TMFs kept for a duration longer than three years would be evaluated as long-term capital gains, plus the benefit of indexation is also extended for long-term capital gains tax. Indexation is the process of adjusting for inflation, which raises the purchase price and lowers the tax obligation.
Low Credit Risk
This fund has minimal default risk because these funds invest in government securities and AAA-rated papers that closely resemble their benchmark. Therefore, the credit risk involved in these funds is comparatively low.
Low Risk If Held Till Maturity
If these bonds are held till maturity, the risks are significantly lower, as the changes in the interest rates, which might affect the value of the underlying bonds, will have no impact if the target maturity funds are held till maturity.
Interest Rate Impact
However, investors may be impacted by interest rate concerns if they withdraw their money before the investment matures. For example, suppose you withdraw from a TMF plan before its maturation date. If the economy is in a rising interest rate trend, the prices of the present bonds could decrease. This is due to the possible introduction of new government bonds with higher interest rates, and you might bear a loss if sold. Accordingly, if interest rates are trending downward and the Reserve Bank of India (RBI) announces a rate drop, the price of existing bonds may increase. Therefore, if you leave early, you can miss out on profits.