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Are target maturity funds well-suited for investors during rising yields?

Such funds can be considered if the investment time frame matches that of the target maturity date of the scheme

March 24, 2021 / 02:31 PM IST

Mutual funds have taken a liking to new debt schemes offers. Through February and March, at least three such schemes – Edelweiss Nifty PSU Bond Plus SDL Index Fund-2026 , IDFC Gilt Index Funds and Nippon India ETF Nifty SDL-2026 Maturity were rolled out. Fund industry observers say many such schemes are on their way.

The question is: when bond yields are rising gradually, why are debt funds being launched? When yields rise, bond prices fall. But such target maturity debt schemes – such as the ones launched so far this year – appear defy this argument.

Rising bond yields are not all that bad

The sharp and consistent fall in interest rates all through last year has nudged many investors – especially in higher income-tax brackets – towards debt funds. Short duration, corporate bond and Banking & PSU Bond funds delivered average portfolio yields of 5.17, 5.28, and 5.10 per cent, as per Value Research, have been popular choices. However, over the last one month, when yields moved up after Budget 2021 announced an enhanced government borrowing program, many of these schemes have seen negative returns making some investors sell.

Here’s where target maturity debt schemes come in and fill the void. These are schemes that invests in bonds maturing in 4-7 seven years. The trick is to invest in bonds whose yields have risen and remain invested till maturity. That way, you get to lock your money at these slightly higher-than-normal yields and reap the benefits by staying invested throughout.

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No credit risk

Credit risk is a worry among many debt fund investors, especially after the collapse of six of Franklin Templeton debt schemes. Here as well, target maturity scores, as typically, fund houses have, at least so far, limited to good quality securities. “Most of these products avoid credit risk by investing into government bonds or state development loans (SDL) or AAA-rated public sector undertakings’ bonds to ensure that the default risk moves out of the portfolio,” says Rupesh Bhansali, Head-Mutual Fund, GEPL Capital.

Target date maturity funds are different from FMPs

In many ways, target maturity funds resemble fixed-maturity plans (FMP). So why plan a new set of funds then?

Typically, FMPs are one or three-year funds, though fund houses are free to launch longer-term FMPs too. And they are closed-end schemes. Target-maturity schemes, on the other hand, are more flexible and come in varying tenures. “The idea behind target maturity funds is to identify pockets of yields that look attractive at a given point in time,” says Joydeep Sen, Corporate Trainer- Debt.

For example, yields on the State development loans (SDL) have gone up. And Nippon India ETF Nifty SDL -2026 Maturity aimed to invest in SDL maturing in 2026 delivering high yields. That’s one opportunity that some target maturity funds have been targeting.

Radhika Gupta, Managing Director and CEO, Edelweiss Asset Management Company says, “Rising bond yields pull down bond prices and thereby give a good entry point to the fixed income investors.”

Also, FMPs are closed-end. But target maturity funds are open-ended; they offer better liquidity.

Indexation benefit

Launching target date funds before the upcoming year-end (March 31) also helps as it give you the added benefit of indexation. The more year-ends that your scheme crosses, the more beneficial it is for you.

For example, if an investor buys a bond fund in March 2021 and redeems his investments in April 2024, he may have held the investments for three years and one month, but still he gets indexation benefit for five years – from 2020-21 to 2024-25. This is perfectly legal and it helps cut the tax burden on the investor and thereby boost the post-tax yield. Ajay Kejriwal, President, Choice Broking says, “Indexation benefit and relatively tight liquidity makes it attractive to launch such schemes towards the end of financial year.”

Should you invest?

The benefit of liquidity has a flipside – interest rate risk. When yields rise, bond prices fall and so do the net asset values of a scheme. Consider target maturity bond funds only if they can hold them till maturity.

But Gupta adds that investors can also add units of target maturity bond schemes after the new fund offer concludes, if their investment time frame matches the target maturity of the scheme.

Amit Bivalkar, managing director and CEO, Sapient Wealth Advisors & Brokers has a contrarian view. “You should wait before committing long-term money in debt.” He expects the yields to move up in line with inflation in near future.

Target date funds offer an interesting option to investors having a clear time horizon. But if yields rise, you will also get more opportunities later.
Nikhil Walavalkar
first published: Mar 24, 2021 02:31 pm

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