With so many mutual fund houses coming out with new fund offers (NFOs) regarding target maturity funds (TMFs), many investors are curious about whether they should substitute their recurring deposit investments with this investment option.
The genesis of this question lies in the assumption that most investors have about returns from these plans. Many of the TMF investors believe that if they hold these plans till maturity, they will earn approximately the same returns promised at the NFO stage.
This assumption has caused many people to shift their investments to TMFs with some of them also stepping up their monthly systematic investment plans (SIPs) while hoping that this strategy will them accumulate a good corpus as planned. This misgiving is more conspicuous among investors with fixed goals in sight. The belief that they would get a fixed amount in the future by allocating money to them can be cited as one of the major reasons for the increased propensity of investors to move from bank deposits to this investment option.
How do TMFs differ from RDs?
No doubt, that TMFs invest in various bonds with a specific maturity date. This means that post the maturity date, the fund management house will sell the bonds and distribute their proceeds to the fundholders. Since the TMFs issued so far are index funds, the belief in their effectiveness is far more with investors not realizing how the net asset value of these bonds is subject to fluctuations owing to demand versus supply forces in the bond market.
Longer-duration bonds fluctuate more than short-tenure bonds. However, irrespective of all the hype surrounding TMFs, can these types of investments be used and treated like recurring deposits to reach a definite financial goal?
Aniruddha Bose, Chief Business Officer, FinEdge shared, “Recurring Deposits (RDs) provide a fixed rate of interest, whereas the NAVs for TMFs fluctuate on basis movements in underlying rates. For traditional RD investors who are used to a linear rate of return, this might be a bit discomforting - so it’s important to acquaint oneself with the dynamics of RDs vs these mutual funds before investing."
Bose explained, "Having said that, TMFs are certainly a viable alternative to RDs if you invest via the SIP route and hold the corpus until the maturity date of the TMF irrespective of NAV fluctuations. Since TMFs follow a roll-down strategy and invest mostly in Government Securities (G-Secs) and State Development Loans (SDLs), you will in a sense be “locking in” to the Yield to maturity (YTM) of the fund at various points of time, much like an RD.”
Suresh Sadagopan, MD & Principal Officer, Ladder7 Wealth Planners said, “Target Maturity Funds invest in securities which mature around a particular point. Hence, this can be compared more to fixed deposits (FDs) than Recurring Deposits (where one contributes an amount for a fixed tenure and gets the accumulated amount at the end of the term).
Rishabh Parakh, Chief Play Officer, NRP Capitals explained, “It is not advisable as it may not be a favourable decision. The RDs are better suited to fulfil yearly financial obligations such as tuition fee payments, contributions to a Public Provident Fund (PPF), or building emergency funds. On the other hand, TMFs could serve as an alternative to fixed deposits, offering investment options with a horizon of five to 10 years.”
“Now, investors face a decision between investing in TMFs or opting for bank deposits, which offer a fixed rate and the guarantee of returns, unlike TMFs which do not provide a 100 per cent guaranteed return. It’s important to carefully consider this choice, especially, since TMFs no longer offer the benefit of indexation. The TMFs offer some degree of return certainty to those who stay invested until the scheme matures. The main downside of TMFs is that investors are locked into current interest rates, which can have a negative influence on overall return, especially when interest rates are expected to rise in the future. If interest rates go on a reducing spree, it will impact the TMFs positively,” added Parakh.
Dev Ashish, a SEBI-Registered Investment Advisor and Founder (Stable Investor) elucidated, “The TMFs, if invested in or near the NFO period, offer a reasonable predictability of returns (which would be YTM at the time of NFO), given their mandate to hold papers with residual tenure matching that of the fund’s maturity date. But at the end of the day, TMF is still a market-linked product. So, the YTM of the fund will fluctuate every day. So, if one does a periodic investment in TMF using the SIP method, the stated YTM for each instalment may vary and might be different than the YTM stated at NFO. So, the actual yield of the period investments, when aggregated, will be different from NFO YTM. And it is for this reason that SIPs in TMFs should not be looked at as an RD alternative.”
Debt fund investors make the mistake of expecting fixed returns from their investments. What many fail to realize is that the yields from these investments depend on the demand versus supply factor in the market and the credit ratings of these bonds.
There is always a deviation of the actual returns from these funds from what is anticipated at the time of the NFO. There are no guaranteed returns since these funds are market linked, thus, explaining how they cannot be treated similarly to fixed-income instruments like RDs.