Should you invest in Target Maturity Funds

Target maturity funds are passive debt mutual fund schemes, which track an underlying bond index and have defined maturity dates. Upon maturity of the scheme, you will get the principal along with accrued interest. Target maturity funds can be in the form of Exchange Traded Funds (ETFs) or Index Fund. Target maturity funds can be good fixed income investment options in this interest rate environment because yields have risen sharply and investors can lock in relatively higher current yields till the maturity of the fund.

Target maturity funds and fixed maturity plans (FMPs)

For many investors target maturity funds may seem very similar to fixed maturity plans (FMPs). Both FMPs and target maturity funds have fixed maturity dates and investors receive redemption proceeds after maturity. However, there is an important difference between target maturity funds and FMPs.FMPs are close ended schemes; you cannot redeem FMP units before maturity.

Target maturity funds are open ended schemes; you can redeem target maturity funds at any time like any open ended scheme subject to the exit load structure of the scheme. Target maturity ETFs trade in stock exchange; so you can sell your target maturity ETFs in the stock exchange or redeem with the Asset Management Company if you are transacting in lot sizes as specified by the AMCs. Target maturity funds offer more liquidity than FMPs.

Further, FMPs can invest in any debt and money market instruments that mature before the maturity date of the scheme. Currently, target maturity funds are mandated to invest only in Government Securities or quasi Government securities e.g. Gilts, State Development Loans (SDLs) and Public Sector Undertaking (PSU) bonds.

How do Target Maturity Funds work?

• Target Maturity Funds invest in Government Securities, SDLs and PSU bonds that mirror an underlying bond index. All the bonds in target maturity funds mature on or before the maturity date of the scheme.


• Target Maturity Funds hold the bonds in their portfolio till maturity and accrues the interest (coupons) paid by the bonds. Upon maturity of the scheme, you will get the principal and all the accrued interests. Interest rate changes will have no impact on your returns if the bonds are held till maturity.


• By holding the bonds till maturity, target maturity funds roll down maturities i.e. maturity reduces with tenure of the investment. Interest rate sensitivity of a bond is directly linked to the bond maturity or duration. Suppose, you invested in a 5 year bond and want to hold till maturity. After 1 year, the residual maturity of the bond will be 4 years, so the interest risk will be lower. After 2 years, the residual maturity of the bond will be 3 years, so the interest risk will be lower. So interest rate risk will reduces over the tenure of the investment in target maturity fund.


• The interest (coupons) received by a target maturity fund from the bonds in its portfolio are re-invested in the underlying bond index.

Why should you invest in target maturity funds?

• These funds have defined maturity periods. You can lock in current yields over certain investment tenure by investing in target maturity funds.


• In uncertain interest rate environment, like the one we are experiencing currently, you have greater visibility of returns (predictable) in a target maturity fund, if your investment tenure matches with the target maturity date.


• Target maturity funds invest in Gilts, SDLs and PSU bonds. Gilts have sovereign guarantee. SDLs enjoy quasi sovereign status since the interest and principal payments of the SDLs are part of the State Governments’ Budgets. PSUs have majority shareholding by the Government, so they also enjoy quasi sovereign status. As such, the credit quality of target maturity funds is high.


• Target maturity funds are liquid. You can redeem units of your target maturity funds with AMCs in case of target maturity index funds or sell them in the stock exchange at market prices in case of target maturity ETFs.


• Since target maturity funds are passive schemes, there total expense ratio (TERs) is much lower compared to actively managed schemes. Two schemes with similar portfolio yields to maturity (YTMs), the scheme with lower TER will give higher returns than scheme with higher TER.


• For investment tenures of 3 years or longer, you can enjoy long term capital gains taxation benefits by investing in target maturity funds. Long term capital gains in debt funds are taxed at 20% after allowing for indexation benefits as opposed to traditional fixed income investment options e.g. bank FDs, which are taxed as per the income tax rate of the investor.

Long term capital gains tax benefit versus traditional fixed income

In this example we have assumed one investor has invested Rs 1 lakh in Bank FD at 6% p.a. interest rate for 5 years, while another investor has invested the same amount in a debt fund giving 6% annualized return for the same tenure. We have assumed that both the investors are in the 30% tax bracket. For indexation purposes, we have assumed 5% inflation rate. For actual capital gains tax computation, you will have to refer to Cost Inflation Index (CII) table to index your acquisition cost (cost of purchase). You can see that the post tax returns of the debt fund investor are significantly higher because of long term capital gains tax benefits.

Note: The figures above are purely illustrative (using the assumptions mentioned above) for investor education purposes only. The returns mentioned in this illustration may or may not reflect current yields or interest rates. Please consult with your tax advisor to know the tax consequences of your investment.

Who should invest in target maturity funds?

• Investors who want predictable income over the residual maturity tenure of the target maturity fund.


• Investors whose investment tenure match with the defined target maturity date of the scheme.


• Investors who have moderate risk appetite, since the scheme NAVs may be volatile when interest rates rise.


• Investors should invest according to their risk appetite and investment tenure. Consult with your financial advisor if required.

How to invest in target maturity funds?

• If you have a Demat and trading account, you can buy target maturity ETF units from the stock exchange through your stockbroker.


• If you plan to remain invested till defined target maturity date of the ETF, the maturity proceeds will be credited to your account, upon maturity of the ETF.


• However, if you plan to sell the ETF units before the maturity date, then you will have to sell it in the stock exchange at market prices. If you are transacting in lot sizes (creation units) as specified by the AMC, then you can redeem the ETF units directly with the AMC at applicable Net Asset Values (NAVs). You can find the creation unit size in the Scheme Information Document (SID).


• If you do not have Demat account, then you can invest in target maturity index funds. Investing in target maturity index funds is like investing in any open ended mutual fund scheme.


• You can redeem units of your target maturity index funds with the AMC at any time subject to exit load structure of the scheme. Please refer to the SID to know the exit load structure of the scheme.


• Upon maturity, the redemption proceeds of your target maturity index fund units will be credited to your savings bank (as provided to the AMC in your application form).

Consult with your financial advisor to discuss if target maturity funds are suitable for your investment needs.