TMFs: Capture current high yields by staying invested till maturity

Select a fund with a longer duration to gain from possible rate cuts next year

Aditya Birla Sun Life (SL) Mutual Fund has launched the Aditya Birla SL Crisil IBX Gilt April 2033 Index Fund. The scheme’s new fund offer opened for subscription on December 15 and will close on December 21. It is an open-ended target maturity fund (TMF) that tracks the Crisil IBX Gilt Index–April 2033.
 

Says A Balasubramanian, managing director and chief executive officer (MD & CEO), Aditya Birla Sun Life Asset Management Company: “The fund has a 10-year portfolio maturity. With its longer duration, it offers investors the potential for enhanced accrual benefits and capital gains.”  

This fund has a portfolio made up of gilts and falls in the category of target maturity funds (TMFs). A TMF is a debt mutual fund with a fixed maturity. 

“They are similar to fixed-maturity plans (FMP). However, investors can redeem them at any point of time, which is not the case in FMPs,” says Vijay Kuppa, CEO, InCred Money.

No credit risk

When TMFs invest in an index comprising government securities (G-Secs), it carries zero credit risk.
 

TMFs are also liquid. Says Jinal Mehta, a certified financial planner and founder of Beyond Learning Finance: “Since TMFs are open-ended and have no entry or exit load, investors can enter or exit them anytime.” TMFs are passively managed, so their expense ratio is low (range is 10 to 50 basis points).

As the portfolio replicates the index, investors know at the time of investing which securities will be included in the portfolio. With the coupon being reinvested, investors get the benefit of compounding.

 

Uncertain returns on premature exit

Investors must stay invested till the end of a TMF’s tenure to earn returns similar to its net YTM. 

Says Kuppa: “Depending on the TMF’s duration, the net asset value can be volatile. If the investor exits before maturity, he may not earn a favourable return.”
 

Choosing the right tenure

The primary consideration in selecting a TMF is its tenure.  Says Kuppa: “An investor who wants a predictable return should try to match their investment horizon with the fund’s tenure. A savvy investor who wants to generate capital gains may invest in TMFs with a higher duration, especially now when it is increasingly becoming certain that interest rates have nearly peaked.” Investors who don’t have a specified horizon may choose a tenure for which the net yield to maturity (YTM) is attractive. Says Dilshad Billimoria, board member of Association of Registered Investment Advisors (ARIA): “The current yield curve is best poised around four years.” On most occasions, the yields of TMFs tracking state govt securities (G-Secs) and AAA bonds are higher than those invested in central G-Secs.

Gains taxed at slab rate
 

Capital gains from TMFs are taxed at the investor’s slab rate under the altered tax regime for debt funds. Says Mehta: “Any income received as income distribution cum capital withdrawal (IDCW) is also added to the gross taxable income and taxed at slab rate.” Experts say mutual funds remain the best instrument to take interest-rate (duration) risk despite the indexation benefit being removed.
 

Who should invest in them?
 

Investors who want a safe long-term play may opt for these funds. Says retired Col. Sanjeev Govila, CEO, Hum Fauji Initiatives: “High interest rates on long-term bonds will provide good accrual income.” Govila adds that the inverse relationship between interest rates and bond prices can also result in capital gains for savvy investors. “Since the fund is open-ended, investors have the option to take calls (like exiting) in case the reversal of interest-rate cycle does not play out as visualised,” he says.
 

TMFs versus FDs and FMPs
 

Many experts favour debt funds over fixed deposits (FDs) and FMPs. Says Billimoria: “Debt funds are still the preferred option over FDs due to liquidity and potential capital appreciation. Also, tax deduction at source (TDS) does not apply. They are taxed only at the time of sale.” FMPs do not offer liquidity. Says Kuppa: “Rather than taking duration risk, FMPs take credit risk. TMFs trump FMPs and FDs when it comes to investing in a high-duration product.”