India’s obsession about knowing ‘kitna deti hai’ goes beyond car/bike mileage, and this has been one of the reasons why retail investors have preferred fixed deposits over debt mutual funds due to the latters’ perceived lack of predictable returns.
According to a recent analysis done by the Reserve Bank of India (RBI) on households’ financial asset holdings, 53% of these assets are held in bank deposits.
To provide context, as of March 2022, households had invested Rs 3.7 lakh crore in debt mutual funds, while a staggering Rs 115 lakh crore were parked in bank deposits, representing a difference of 30 times more in fixed deposits than in debt mutual funds.
This is glaring, given that fixed deposits have on an avegrage deliver lower post tax returns specially for investors that attract higher marginal tax rates.
So, the issue of debt funds not offering return predictability and FDs not being tax efficient persists. Is there a better option? This issue appears to be resolved by Target Maturity Funds.
What are Target Maturity Funds (TMF)?These are open-ended passive debt mutual funds that have a defined maturity date. TMFs invest in a portfolio of bonds and hold them until maturity, to provide a reasonably predictable return. It basically combines the benefits of individual bonds and a mutual fund.
But how does TMFs provide reasonable return predictability?
Suppose you buy a bond maturing after 6 years, that promises to pay 8% coupon annually and the principal amount at the end of 6th year. If you hold the bond till maturity, your pre-tax returns will be 8%, assuming no reinvestment risk.
TMFs do pretty much the same thing. They buy a portfolio of bonds and hold these bonds until maturity. Partially, as a result of this attribute the TMF segment has seen phenomenal growth in past couple of years.
From being non-existent a few years back to having more than 70 funds managing ~Rs 1.5Lac Cr, this segment has come a long way.
So how does TMFs fare against other similar offerings?
ET CONTRIBUTORSWhat are key attributes of Target Maturity Funds?
Liquidity – As these are open-ended funds, they offer investors easy entry/exit. Unlike Fixed Deposits, it doesn’t have any lock-in.
Returns Visibility – As TMFs invest in bonds that mature just around the fund’s maturity, it offers higher visibility of returns.
Tax Implication – Like any fixed income/debt mutual funds, TMFs are eligible for indexation benefit for investment periods greater than 3 years.
How are TMFs tax efficient?
TMFs, like any other debt fund if held for more than 3 years (LTCG) are taxed at 20% with indexation benefit, whereas for periods less than 3 years it is taxed at individuals’ tax slab.
A simulation of post-tax returns shows that basis prevalent yields/rate, the TMFs seem to be better alternative to fixed deposits and tax-free bonds
ET CONTRIBUTORSIs it a good time to invest in TMFs?
Central banks worldwide, including the RBI, have resorted to unprecedented rate hikes to contain inflation. From May 2022, the RBI has increased the repo rate by 250 basis points, resulting in a successful reduction of inflation to a manageable level.
Hence, the market is of the view that the yields may have peaked out with little room for further uptick. As such it may be an opportune time for investors to lock-in their investments at these levels, using a Target maturity fund.
To summarize, Target Maturity Funds seem to have bridged the gap between open ended debt mutual funds and fixed deposits. They provide investors visibility of returns and at the same time are tax efficient.
These funds are best suited for an investor seeking high safety, transparency, and whose investment horizon is similar to that of fund maturity.
(The author is Head-Research of Passive Funds, Motilal Oswal Asset Management)
(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)
