Debt mutual fund investors are faced with two primary risks, interest rate risk and credit risk. While long-duration G-Secs address credit risk well, they are prone to high-interest rate risk. On the other hand, short-duration funds or liquid funds offer better management of interest rate risk but suffer from credit quality issues.
FMPs and Target Maturity funds have fixed maturities and hence are better placed to manage interest rate risk through a buy and hold strategy. However, Target Maturity Funds score a few points above FMPs in certain respect. Apart from addressing interest rate risk, they are also better placed to handle credit risk as compared to FMPs since their portfolio consists of G-secs, State Development Loans and AAA-rated PSU bonds.
FMPs are close-ended funds and even though they are listed on exchanges, they don’t offer much liquidity due to low transaction volumes. Target Maturity bond funds are open-ended in nature and hence offer better liquidity. Target Maturity Funds are also available in three different formats i.e they are available as Target Maturity Bond Index Funds and Target Maturity Bond ETFs. Thus, Target Maturity Funds offer more choices to investors in terms of the structure of the fund.
Being passive in nature, Target Maturity Funds have a lower expense ratio compared to FMPs where the fund manager has to build the portfolio. Target Maturity Funds also offer greater choice in terms of maturity ranging from 3-10 years while most FMPs are usually in the 1-3 yr range. Hence FMPs may not be suitable for investors having longer goal horizons.
FMPs score over Target Maturity Funds in one aspect because they are close ended. While this limits their liquidity, it also forces serious investors to stay invested till the fund matures and hence protects them from interest rate risk. Since Target Maturity Funds are open-ended, that doesn’t mean you should invest in them without committing yourself to remain invested till the maturity date. If you fail to do so, the whole premise of locking in a yield and interest rate risk protection is lost. Hence Target Maturity Funds are suitable for only those investors who can stay put till the maturity date of the fund and the whole goal horizon matches the fund’s maturity date.