Index investments make target maturity funds more transparent: Experts

With the end of the financial year approaching, fund houses are launching fixed maturity plans (FMPs). New fund offers (NFOs) of FMPs from SBI Mutual Fund and IDFC Mutual Fund are on at present. In addition, HSBC Mutual Fund’s NFO for a target maturity fund (TMF) is also underway.

A large number of TMFs catering to different investment horizons already exist. FMPs and TMFs have many similarities.

“In both, investors have clarity on when they will get their money back. By holding till maturity, they can cancel out interim volatility in a rising interest rate scenario. They can also avail of indexation benefits on both,” says Arnav Pandya, founder, Moneyeduschool.

FMPs losing ground

In recent times, however, FMPs have lost ground to TMFs. One selling point of FMPs was that by investing in the last few days of a financial year, an investor got an additional year’s indexation benefit by holding the fund for an extra 10-15 days.

“This allowed FMPs to score over fixed deposits,” says Prateek Mehta, co-founder and chief business officer, Scripbox.
 

This pitch worked better in the past when indexation benefit was available after one year. Investors would hold the fund for slightly over a year and get the benefit for two years. But once the indexation benefit became available after three years, the attractiveness of this proposition diminished.

“Now, investors have to hold an FMP for three years plus to get the benefit of four years of indexation,” says Deepesh Raghaw, founder, PersonalFinancePlan, a Securities and Exchange Board of India-registered investment advisor.
 

Many investors also had poor experiences in FMPs in the aftermath of the IL&FS credit crisis. Some fund managers invested in portfolios that included lower-grade papers. When some borrowers failed to pay on time, some AMCs also failed to redeem investors. This eroded trust.  
 

In an FMP, the portfolio is not ready, so an investor can’t see it at the time of the NFO. She is only told about the kind of bonds that will be included in the portfolio.
 

If something goes wrong (say, a borrower defaults), investors have the option to sell on the exchanges and exit. “But liquidity is likely to be poor. Even if you get liquidity, you may have to sell at a large discount to the net asset value (NAV),” says Pandya.
 

TMFs: Rule-based portfolios

TMFs, on the other hand, invest in an index. “The construction of these indexes is rule bound. Nothing is left to the fund manager’s discretion,” says Raghaw.
 

Before investing, the investor can see the exact bonds that constitute the index. Most of these funds invest in G-Secs, state development loans (SDLs), and ‘AAA’ public-sector bonds, so credit quality tends to be high. “TMFs also offer greater variety than FMPs on investment horizons. They offer longer maturity options,” says Pandya.
 

Since these are open-end funds, investors can exit in case of problems. If the TMF is in the index fund or fund-of-fund format, they can redeem at NAV by selling their units to the fund house. In the ETF format, liquidity varies from one issue to another. “Usually, ETFs don’t trade at the kind of discount to NAV at which closed-end funds do,” says Pandya.
 

Selecting the right TMF

One, you could choose a fund whose maturity matches your investment horizon. Two, you could compare yields to maturity (YTMs) of funds and select the one you like. Three, interest rates appear likely to rise. You may opt for a shorter maturity TMF now.
 

By the time this fund matures, interest rates would hopefully be higher. “You could then lock into a fund having a longer horizon,” says Pandya.

Bear in mind a few points. “Avoid NFOs of TMFs. Invest in one whose AUM is reasonably large as these are likely to be less affected by panic-driven outflows,” says Mehta. 
 

Finally, stay invested till maturity. “If you exit in between, you could be hit by interest-rate volatility,” says Pandya.