Many risk-averse investors who were accustomed to conventional products like bank fixed deposits, PPFs, and NSCs have migrated towards debt funds for good reasons as knowledge of mutual funds has increased and interest rates on guaranteed savings products have decreased. For these investors, debt funds have the potential to provide higher returns while being less volatile than the more well-known equities funds and more tax-efficient than their fixed deposits, PPFs, and NSCs. Investors are still vulnerable to interest rate risk and default risk, or the risk of missing out on principal and interest payments, respectively.
By coordinating their portfolios with the fund's maturity date, target maturity funds (TMFs) assist investors in better navigating the risks related to debt funds. These are passive bond funds that follow an index of underlying bonds. As a result, these funds' portfolios are made up of bonds from the underlying bond index, and these bonds have maturities that are close to the stated maturity of the fund. All interest payments collected throughout the holding term on the bonds in the portfolio are reinvested in the fund, and the bonds are held until maturity. As a result, Target Maturity bond funds run in the same accrual mode as FMPs. TMFs, in contrast to FMPs, are open-ended in nature and are available as target maturity bond ETFs or target maturity debt index funds. As a result, TMFs provide more liquidity than FMPs.
Since all of the bonds in a TMF's portfolio are held to maturity and reach maturity around the same time as the fund's declared maturity, TMFs have a homogeneous portfolio in terms of duration. By keeping the bonds to maturity, investors may reduce the duration of the fund over time, which makes them less susceptible to price volatility brought on by changes in interest rates.
Currently, TMFs must invest in PSU bonds, government securities, and SDLs (State Development Loans). As a result, they have a smaller default risk than other debt funds. Due to the open-ended nature of these funds, investors have the option of withdrawing their money in the event of any unfavourable developments involving the bond issuers, such as the probability of a default or a credit downgrade.
Target Maturity Funds should preferably be kept until maturity despite their open-ended structure and promise for liquidity since this offers some predictability of return, a consideration significant for investors switching from traditional deposits to debt funds for the first time.