If you are a mutual fund investor, you might have heard of debt mutual funds quite often. They are one of the most discussed category of mutual funds.
Debt mutual fund schemes invest in fixed income producing assets such commercial papers (CP), certificates of deposit (CD), corporate bonds, Treasury Bills (T-Bills), government securities, and other money market instruments. These financial instruments have a set maturity date and interest rate that buyers can receive up to the security's maturity.
Two of the the many debt mutual funds which are gaining popularity are Target maturity funds and Fixed maturity plans. Due to their set maturities, Both of these funds are better equipped to manage interest rate risk through a purchase and hold strategy.
However there are some areas where one scores above the other. Let us try to draw a comparison between the two. But first, let's quickly go through them.
What are target maturity funds?
Bond-investing debt funds that follow an index are known as target maturity funds (TMF). TMFs offer guidance to investors as they navigate the risks of debt funds. These funds link their portfolios with the maturity date of the fund.
Bonds included in the underlying bond index and with maturities near to the fund's maturity make up target mutual fund portfolios. The bonds are held until maturity, and any interest income collected throughout that time frame is reinvested in the fund.
What are fixed maturity plans?
Fixed maturity plans (FMPs) are closed-end mutual fund schemes that are debt-oriented and have a specified maturity profile. The investments made by these plans are made in debt or money market securities that mature on or before their maturity date.
As closed-ended investments, FMPs prohibit investors from freely entering or leaving the fund at any moment. They are only available for subscription for a limited time once the asset management company launches the plan. However, investors can buy or sell the scheme's units through a recognized exchange, where these FMPs are listed.
Target maturity funds vs Fixed maturity plans
- Target maturity funds, as opposed to FMPs, are better equipped to manage credit risk as well as interest rate risk because their portfolio includes G-secs, State Development Loans, and AAA-rated PSU Bonds.
- Target maturity funds offer a wider variety of maturity options, ranging from 3 to 10 years, compared to most FMPs, which are typically in the 1-3 year range. FMPs may therefore not be appropriate for investors with longer goals.
- Even though FMPs are close-ended funds and are listed on exchanges, their low transaction volumes prevent them from providing considerable liquidity. However, target maturity bond funds offer improved liquidity because they are open-ended in nature.
- Target maturity funds, which are passive in nature, offer a lower expense ratio than FMPs, which need the fund manager to create the portfolio.
- Due to their close ended nature, FMPs have an advantage over target maturity funds in one respect. This restricts their liquidity while also requiring serious investors to commit to the fund until maturity, shielding them from interest rate risk.
TMFs have several advantages over FMPs, but their primary downside is the lack of a historical performance and track record. To sum up, TMFs are most suitable for investors that have a conservative investment approach and a five- to six-year investment horizon.