Can I use Target Maturity Funds like recurring deposits?

Published: May 1, 2023 at 6:00 am

A reader asks, “I have been reading a bit on Target Maturity Funds and wanted to know if these can be used like a recurring deposit. Example: Let’s say I wish to buy a house in 2031. I want to create a substantial amount for the down payment”.

“I intend to build the corpus through SIP in HDFC Nifty G-Sec July 2031 Index.
I read online that if we hold the amount till maturity, we will approximately get the expected return at the NFO stage (YTM)”.

“So if I start a SIP now and step up as my salary increases, I should be able to accumulate a good sum for the down payment. Unlike equity which may be down just about the same time I plan to purchase”.

“So my question actually, in a nutshell, is if I can use Target Maturity funds for my goals which is a fixed amount in a future time?”

Caveat: With the change in debt mutual fund taxation, it is possible that AMCs may no longer be interested in issuing target maturity funds, or they may issue them bundled in with arbitrage.

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For those who wish to know the basics of target maturity funds, we have a detailed FAQ. Here is a snippet.

1 What are Target Maturity Debt Funds? These are open-ended funds investing in various bonds with a specific maturity date. That is, before a given date, the fund manager will sell all the bonds and hold cash. After the maturity date, the cash will be proportionally distributed to unitholders.

In order to facilitate this process, all target maturity funds issued so far are index funds. That is, they track a bond index.

2 What is the benefit of a target maturity date? The NAV of a debt mutual fund fluctuates on a daily basis due to demand vs supply forces in the bond market. This is known as duration risk (or colloquially and incorrectly as interest rate risk). The longer the duration of the bond, the higher the fluctuations.

If a bond fund manager buys and holds 5-year bonds, the NAV fluctuations in the first holding will be highest. It will be lower in the subsequent years. So if the target maturity date is 5Y from now, the fund manager will buy bonds maturing a month or so before the fund maturity date. This will result in NAV growth with progressively decreasing volatility.

3 What return can I expect from these funds if I invest at the NFO stage? The worst mistake a debt fund investor can make is expecting some fixed return! The returns from these funds will depend on two primary factors: (1) Any sudden deviation in demand vs supply in the market (like it happened during the March 2020 market crash) will result in a deviation from the expected yield and actual yield; This is highly probably over the tenure of the fund.

(2) If the credit rating of a bond changes, then such a bond can be replaced by another. (3) Coupon payments will be reinvested at market price. In contrast, the yield to maturity (YTM) assumes the reinvestment is done at the issue price or current price.

These factors will result in a deviation of the actual return from the stated yield to the maturity of the portfolio at the NFO stage. Never forget that target maturity funds are market-linked products, and no return can be guaranteed. If the final return of the fund is close to the NFO YTM, it is more due to luck and not a plan.

Yes, there is a reasonable chance of getting a return close to the NFO YTM for purchases made at NFO. Subsequent purchases (SIP or set-up SIP) are made at market price, and the final return can differ from the initial YTM.

So these are not replacements for recurring deposits. They are less riskier than open-ended debt funds assuming no credit issues. That is about it. With the change in tax rule, they would be marginally more tax efficient than an RD.

Conservative investors or new investors can opt for an RD and sleep peacefully. Target Maturity Funds are only suitable for experienced debt mutual fund investors.

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