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Today, target maturity funds come with multiple maturities: one year to 15 years, and this makes it very easy for investors to choose just one of these target maturity funds that suits their needs and forget about everything else. They don’t need to look at the bond markets and guess which way interest rates will go and how they will move through them.
One thing that is catching the eye of many investors is rising yields in the bond market. Bond yields are rising even as fixed deposit rates at banks remain stuck, slowing interest rates across the economy.
India’s three-year bond yield was at 7.3%, versus 6.10% for SBI’s three-year deposit rate, a difference of 110 basis points. In such a scenario, debt mutual funds seem to be a better option in terms of post-tax returns, especially if the investment is for three years or more. But choosing a debt mutual fund itself can be confusing if one brings open-ended debt funds like JISC funds, short-term funds and corporate bond funds to maturity.
As a general rule of thumb, bond prices fall when interest rates rise and bond prices rise when interest rates fall.
Open-ended debt funds are designed to generate returns from two sources: accruals, or interest rates, from the bonds in which they are invested, and changes in the value of the bonds, if they are invested. TR = accrual (portfolio YTM) +/- return from the change in the value of the bonds in the portfolio.
As one can judge, returns from changes in bond prices can vary widely. This means that when an investor invests in an open-ended debt fund, the return earned may be more or less than the YTM of the portfolio. For example: In a fund with a 7.50% YTM and a fixed tenure of three years, returns can vary between 4.50% and 10.50% as interest rates change.
This suggests that if one wants to get higher bond yields today and wants to lock in investments in current yields, investing in open-ended debt funds may not be the best way to go. But what could work is a target maturity index fund.
These funds are designed to generate returns that are close to the YTM over the investment period, which means one stays invested till the fund matures. During their maturity, these funds generate returns only if they are accumulated. This means that any changes in interest rates will not affect the fund’s total return to maturity.
TMFs have specific maturity dates. These funds invest in bonds with maturities commensurate with the fund’s maturity. This means that a fund starting today with a target maturity of April 2027 will invest in bonds maturing over the next 5 years and the average maturity will decrease as time passes. After one year, this fund will have an average maturity of four years, and after three years, the average maturity will be reduced to two years.
This brings TMFs closer to any traditional investment product like deposits, one that has return visibility and seeks to lock in your return at a specific YTM.
A target maturity index fund is one, which tracks an index of the same maturity. The April 2027 Maturity Index Fund tracks an index with an April 2027 maturity. The index components will be the universe for this fund and ensure transparency. These funds have a bond-like structure where you invest in a specific product and hold it until maturity, and these funds are designed to generate returns that can be close to the WTM over the follow-up period. Error TMFs are available in 1-year to 15-year maturities and can be used for short-, medium-, or long-term goals, depending on the time frame.
(Niranjan Avasti is Head Product, Marketing and Digital, at Edelweiss Asset Management)
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