An investment in Target Maturity Funds combines the best of traditional savings products and debt funds. With the Reserve Bank of India (RBI) increasing interest rates earlier this year, Target Maturity Funds make for a great tool to diversify your investment portfolio and add some debt to it.

Central banks around the world are trying to defeat high levels of inflation by rapidly increasing interest rates and India has been no different. The Reserve Bank of India (RBI) has increased the repo rate by 50 bps to 5.90 per cent. India's benchmark 10-year bond yield also subsequently rose to ~7.50 per cent. So, with interest rates peaking, should investors lock in the high yields by investing in Target Maturity Funds?

Target Maturity Funds, are essentially open-ended debt funds with a specific maturity date. At the time of maturity, the principal and interest are both paid out to the investor. Ever since the first Target Maturity Fund was launched in December 2019, there has been a noticeable preference for passively managed Target Maturity Funds among investors. In fact, investor assets managed by Target Maturity Funds have grown more than 7 times since then and have crossed the Rs 1 crore mark as per data from August 2022.

The reasons for this draw are many. An investment in Target Maturity Funds offers predictability of returns as the fund aims at giving returns closer to the yield to maturity date of the index. So, as an investor, you are locking in your returns based on the interest rates of today and can expect the indicative yields, provided you hold your investment till the date of maturity.

According to regulations laid out by Securities and Exchange Board of India (SEBI), Target Maturity Funds can invest only into Government Securities (G-Secs), State Development Loans (SDLs) and PSU bonds that mirror an underlying bond index so you can consider your investment to be ‘safe’ as the credit quality of Target Maturity Funds is very high. Furthermore, investors tend to reap the gains from roll down maturity portfolios when interest rates are higher, thereby offering a boost to the returns.

Investors also gain from the power of compounding as the bonds that the funds invest into pay out interest at regular intervals which gets reinvested into the fund itself, increasing the total corpus that it is reaping benefits from. Target Maturity Funds are a great diversification tool for those investors who are looking to add some element of debt to their portfolios.

As Target Maturity Funds are open-ended, you can enter and exit the fund at will. In some situations, investors may want to redeem the units before the date of maturity of the fund. While this offers high levels of liquidity, it can affect your expected returns. You can lock-in the current interest rates only if you hold the fund till the date of maturity.

Secondly, if the target maturity date is more than 3 years from your date of investment in a Target Maturity Fund, you can get the benefit of long-term capital gains taxation. This will give you indexation benefits to beat the impact of inflation on your investment. Long term capital gains in debt mutual funds are taxed at 20 per cent. It is also imperative to time the investment right in order to maximise the portfolio returns.

In conclusion, Target Maturity Funds combine the best of traditional savings products and debt funds. With the Reserve Bank of India (RBI) increasing interest rates earlier this year, Target Maturity Funds make for a great tool to diversify your investment portfolio and add some debt to it. You can lock in your yields at today’s interest rates, which make it even more attractive.

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