At a time when the Reserve Bank of India has increased the repo rate to 190 basis points since May this year, asset management companies are launching target maturity funds as they are less prone to interest rate risk than standard bond funds. These index-tracking debt funds invest in government securities, State Development Loans and corporate bonds that are held till maturity. One can get a better visibility of the returns if they stay invested till maturity.
Individuals should invest money in target maturity schemes that mature in three to four years now and then invest in longer duration when the interest rates peak out. In these funds, the volatility reduces as the y get closer to the target maturity, and as a result, investors are less susceptible to price volatility caused by interest rate changes. As the bonds are held to maturity, the interest payments during the entire holding period are reinvested in the fund.
The rolling down maturity in these passive funds means that the duration of a bond portfolio reduces over time and investors who are targeting specific segments of the yield curve can invest in these funds without being locked in till maturity. As target maturity funds offer a wide range of tenures, it is ideal for those looking for medium-term goal-based investments with higher predictability of returns.
The default risk of target maturity funds is lower as compared with other debt funds as these mostly invest in government securities and bonds of public sector companies. Unlike fixed maturity plans, these funds are open-ended. So, investors can sell or redeem units at any time on the stock exchanges, especially in cases of a default or a credit downgrade. Upon the maturity date, the units of the scheme are redeemed at the net asset value (NAV) applicable on the maturity date. The funds also have a low expense ratio.
What to keep in mind
If investors do not hold the fund to maturity then the volatility in interest rates will significantly affect the investment. So, in a rising rate environment, the holding period of the investor must be aligned with the targeted maturity of the fund. Experts say investors must avoid early exits as then the investment may be subject to interest rate risk.
Investors must analyse the tracking error of the fund, which is the difference between actual and benchmark returns. A high tracking error in the fund will indicate higher divergence between the fund’s returns and the benchmark’s returns. So, opt for the target maturity fund that has low tracking error to earn higher returns in the long run.
Investors must note the concentration risk in a particular scheme. For instance, if a scheme predominantly invests in government securities, there could be implications on its performance as it may be more sensitive to economic, political or other changes that may directly impact the G-Sec spreads and may lead to sizeable fluctuation in the NAV.
For taxation, target maturity funds are treated as debt funds. If an investor holds the fund for over three years from the date of investment, he will get the benefit of long term capital gains tax with indexation benefits. Thus investors in the higher tax bracket can benefit by investing in these funds for over three years.
EYES ON THE GOAL
Invest in target maturity schemes that mature in three to four years now and then invest in longer duration when the interest rates peak out
In times of rising rates, align your holding period with the targeted maturity of the fund
Investors in the higher tax bracket can benefit by investing in these funds for over three years