The Mutual Fund Show: When To Consider Target Maturity Funds

Salonee Sanghvi: A lot of people would know about FMPs (fixed maturity plans), which used to be there a few years back. So, Target Maturity Funds are somewhat similar in the sense that the fund will have a fixed maturity. You know exactly when it's going to mature. All the bonds that the fund invests in will have a similar maturity, and they are held till maturity.

So, it's a passive debt fund. There is no trading of bonds that happens in the fund. Now, why would one look at Target Maturity Funds and not look at other debt options? First of all, Target Maturity Funds, in India especially, largely invest in either government bonds, PSU bonds, or state development loans. So, your default risk is extremely low in that case.

Secondly, they are open-ended, so it's very easy for you to redeem it in case you need funds at any point in time.

One reason why people like fixed deposits is that they know exactly what interest rate they are getting when they are investing. Similarly, with Target Maturity Funds, when you invest your yield is locked-in to an extent, you know exactly what yield you will get if you hold till maturity.

And the third point is, of course, you have the long-term debt taxation. So, if you hold for more than three years, then you have that advantage as well.

So, I feel Target Maturity Funds are a great way to invest for debt allocation in your portfolio.

Amit Bivalkar: Most importantly, (there) is the credit risk perspective which one needs to look at. You had a lot of accidents going into 2018-19 on debt funds, and this happens typically when credit growth rate goes beyond 13%.

So, we are currently at 11-12% on the credit growth rate. To fructify that default, it takes about two years from now.

In fact, we were at 20-22% also in 2013-14. So, if you see that credit growth is growing at a rapid pace, that means you will have some people who don't deserve credit, they also get money and that is a big risk when it comes to debt mutual funds which we have seen earlier.

If you are going to invest in a state development loan or a government security or AAA corporate bond, then that risk is actually minimised. You are looking at certainty of income after a certain period with indexation benefit, and with maturity of your monies at the time where the fund also is maturing at the same period.

There is no asset liability mismatch, so to say, wherein I am investing for three years with a six-year duration product. I am investing for three years with a three-year duration, three-year maturity product, which means that the volatility in that product as we come closer to maturity is low and the predictability is going to be high.

So, when you invest in fixed income, predictability is important. Along with that, if you get tax efficiency and liquidity, then Target Maturity Funds will tick all these boxes.

Plus, the credit risk if we invest in funds, which are into SDLs and government securities, is minimised.

So, if you have your maturity matching that of the fund, if you have indexation benefit, and if you look at the portfolio and like it, you will have a post-tax better experience in Target Maturity than any of the (other) products for the next three to four years.

Amit Bivalkar: If I need money in 2025, I should look at a fund which is maturing in 2025. I should not be investing in 2024 because then the reinvestment risk comes into play. I should not invest in 2027 because then I might have the mark-to-market coming into play. So, I should match my maturity with that of the fund. There are loads of funds which have different maturities, right from 2023 to 2027. So, you can choose any one which you like, look at the portfolio, and then just invest.

Salonee Sanghvi: It definitely still holds true because when you invest today, you know exactly what the yield is on the portfolio. So, you know exactly what you are getting. Now, if you are holding till maturity, in the intermediate even if interest rates go up–your NAV might go up and down–but ultimately you are going to get the yield that you were to get when you invested in the fund itself. So, in this kind of a situation, if you hold till maturity, it doesn't impact your return to that extent, even if the interest rates are going up.

Salonee Sanghvi: Usually, Target Maturity Funds have a 3-10 year maturity and the yields currently are about 7.2-7.7% as the maturity increases.

Also, in case you don't have a fixed time horizon for investment, then you can also look at staggering your investment across maturities, so that you are getting funds over a period of time.

Amit Bivalkar: It is up to the investor, what is his requirement of money and when does he want the money back.

One of the Bharat Bond ETFs is maturing next year. So, if you have money for one year, and if you are willing to look at the portfolio and invest, you should definitely invest.

(It’s) More to do with true-to-label funds, what they say where the money will go and the actual portfolio. Since this is like an open-ended FMP, you will always have the choice to come out, if that is not true-to-label.

The risk of an FMP was that once you invest, you couldn't redeem the money. Here you have that option of getting out.

So, match your maturities with that of the fund. Look at the portfolio and I think from 2023 till 2028-29, you have a lot of options.

No specific fund houses because the underlying bonds and the securities are going to be common. They are available across funds and across maturities.

Salonee Sanghvi: I agree with what he said. Edelweiss has the largest basket, in terms of maturity, because most fund houses may have one or two options. Edelweiss has a lot more options. So, you might be able to match the time horizon.

Amit Bivalkar: One point is that cost of money and availability of money, these two factors you should bear in mind. Cost of money is going up; the availability of money is coming down. And when you have availability of money going down and cost of money going up, in the next 3-6 months, you might get a golden period of investing in such funds, because the rates will be high and the liquidity will be low.

So, you will get a better squeeze out of bonds at that point of time. I feel maybe August till December might be a good time wherein you might have peaking in terms of yields, and you can lock-in at those yields then.

Amit Bivalkar: In four-five months, you will stagger out and get a better yield. So, your liquid today is at 5%, which was 2% last year.

You are investing in a debt fund basically to have a post-tax better than fixed deposit return. I think that is pretty much possible now, and this is going to be like the 2014-2018 period, when you had high interest rates and good FMPs coming in.

We had a quarterly interval plan also at that time, if you remember. So, fixed income is going to be the way forward for the industry as well, because rates will be high and whenever you have a pressure on corporates because of high rates, equities falter and debt becomes the mainstay. So, that is going to be an important asset class going forward.

Amit Bivalkar: There's only one Nobel Laureate in wealth management. But if you look at his portfolio, he always maintained a 50:50. He never really did anything with this portfolio–equity 50 and debt 50–and he made tons of money. And the same is the case with Warren Buffett. Whatever asset allocation, he has stuck to it. So, we might discuss all of this but what is good for you according to willingness to take risks, I think you should follow that.

Amit Bivalkar: Risk-o-meter is just a tool to show what kind of risk this product actually carries. For example, it starts from one and ends at six–from low, low to moderate, moderate, high, and very high.

Now, a very high on the risk-o-meter might be for a certain set of clients. But if I am a guy who likes to take risks, a very high would be normal for me. So, like all the international funds–international ETFs–they are by default termed as very high. But I might be bullish on tech, and I want to invest. So, it might not be high for me because I understand tech. So very high, high, this is for general classification of funds.

There are three important factors when it comes to risk-o-meter, and this is more to do with equity funds. One is your market capitalisation. SEBI has defined the market capitalisation–large cap, mid cap and small cap. That is weight of 5, 6, and 7.

Then, there is the volatility factor. A volatility factor greater than 1% and less than one, they have a factor for that.

Then, you have an impact cost. Impact cost is very important, because you might have some illiquid stocks in the portfolio, which impact the NAV when you sell or buy. So, look at the impact cost also.

A simple average of all of this put together along with the weightage is actually your risk-o-meter score.

And that risk-o-meter score then tells you whether it is 4, 5 or 6 and then accordingly, whether it is moderate risk or high risk or very high risk. So, very high risk means that the volatility is going to be high, and it is for a long duration, and you can expect capital growth and good returns over long periods of time.

So, I will put it that low to high is also your duration of money. That low means that you can put shorter duration of money into those products.

Very high is five years and beyond. If you want to put money away for five years and beyond, then those are the products you should put it in.

Salonee Sanghvi: The risk-o-meter is a great way to distinguish risk on an overall level like between debt and equity. But if you look within equity, it does not really do justice to the risk that it carries.

For example, large-cap and small-cap funds have the same risk, which is very high. Sectoral funds also have the same risk–very high. But we know that small cap and sectoral funds are far riskier than large cap.

So, by itself, a risk-o-meter is not a great measure of risk. What we can instead do is there are various other measures that look at risk, that measure it, because risk is a key component of what funds you pick. You need to know how risky they are.

Standard deviation is an easy parameter and is easily available online as well. There are lots of websites that have it. Another factor to understand risk is whether a fund is aggressive or defensive. So, there's something known as a capture ratio, which measures how well a fund performs when the market goes up. It measures essentially if the outperformance is when the market is going up, or when the market is falling and the fund manages to restrict the losses.

Various websites, Morningstar, etc., all of them capture these data points. So, you can easily get it online. So, I feel that maybe a standard deviation and a capture ratio would be a far better measure of risk for mutual funds, especially equity mutual funds versus the risk-o-meter.

I will give you one example. I looked at two large-cap funds–the Axis Blue Chip and Nippon Large Cap. But the standard deviation of Axis Blue Chip is 18, whereas for Nippon Large Cap, it's 25. But every fund will have the same risk, which is very high. So, there are better ways of looking at risk.

Amit Bivalkar: I will just add one point to what Salonee said. If you look at Balance Funds over a long period of time–12-15 years–standard deviation is low compared to an equity fund, but the returns are superior.

So, you take the industry, put it into diversified equity and Balanced Funds, and look at the standard deviation and the returns. Most of the Balanced Funds have outperformed their diversified equity funds over long periods of time.

Amit Bivalkar: Yes. So, if you try to look at it, then Balanced Fund has a lesser risk in the risk-o-meter compared to a diversified one, but they have outperformed in terms of returns.

When we say higher risk, higher return, it doesn't get applied on the risk-o-meter here. At times, you will have the debt market doing the trick for you. Since Balanced Funds have 30-40% debt–when others are losing money in diversified, this debt portion actually makes it up.

Amit Bivalkar: Not really. Asset allocation is the game. So, when you have debt and equity together, it might reduce risk and enhance returns if you use it properly in your portfolio.

Something to digress. People always talk of 1980s, of Sensex at 100, and today at 59,000-56,000, and we say 14% compounded return on Sensex. Nobody compares it with Nifty. Nifty started in 1995 and from then till date Nifty return is 12%, not 60%, not 14%. What data to look at–which suits you or which is actually the data to look at.

So, this also needs to be seen–what is my return expectation going forward. Risk-o-meter will tell you what is risky, it will not tell you what your return is. So, that expectation also has to be managed.

Salonee Sanghvi: An NFO could be a great investment if it adds a new sector or category to your portfolio. But given the current situation, we have a lot of tried and tested funds in almost all categories. So, I would prefer sticking to those because we know how they have done across a bear market and the bull market, and you know exactly how that fund behaves.

But that being said, I am definitely keeping a watch on the White Oak Flexi Cap because of the management pedigree since it's led by Prashant Khemka who was the CIO for Goldman Sachs, Global Emerging Markets Equity. So that's something I am definitely keeping an eye on, but I would wait and give it some time to see how it does over a period of time before investing.

Amit Bivalkar: What is important is do I have something missing in my portfolio? You have to distinguish between what you need and what you want; you might want everything, but do you need it actually?

So, as a distributor, I might not have ‘X’ fund house with all my customers. So, I might go and market that fund. Whether it is needed in the client's portfolio, that is a question. So, a framework of the fund house, a process, if I like and feel that this process is unique, and I can offer it to my customer, definitely I should be offering that.

Otherwise, any different theme, any different sector which is not there in many people's portfolio, that has to be considered as well.

So, no ‘me-too’ products when you are considering NFO. Buying four Balance Advantage Funds, five diversified large caps doesn't make sense.

Over time, you will see all of them give the same returns. So, you don't need to have a long list of funds in your portfolio. Maybe five, six funds in your portfolio are good enough. So, don't go for the marketing of the fund. Look at the framework, look at the processes and if something is missing in your portfolio and you get the opportunity to buy that, then I think you should be willing to buy that.

Amit Bivalkar: So, it is not about excitement. You have portfolios for established funds. So, I know exactly what I am buying for my customer by looking at the portfolio.

Before going into any NFO, we must actually look at where is your money going. We will be happy looking at the portfolio and then allocating money.

NFO is just 15 days. The fund opens back in five days. So, continuous sale starts after one month, and I don't think you will lose much by not investing or investing in an NFO.