Funds with a shorter portfolio maturity, for example liquid funds or other money market funds, have lower duration risk, but carry an element of credit risk.
One method of managing volatility risk is to follow maturity (HTM). This concept can be practiced by investing directly in bonds. When the bond matures, the money comes back to the investor and returns are independent of market conditions at that time. In mutual funds, fixed maturity plans (FMP) work on this principle. If it is a three-year FMP, at maturity all bonds in the portfolio mature and there is no market / volatility risk.
For credit risk management, G-Secs are assumed to be risk free. Along with Gilts, government-issued securities called State Development Loans (SDLs) are placed in the same category as G-Secs. PSU bonds rated AAA are also of very high credit quality, alongside G-Secs.
The risk management approach
In light of what is mentioned above, this three-pronged approach allows:
- In a mutual fund system, do an HTM. While FMPs typically have a three-year term, they have funds with multiple maturities, such as three years, six years, 10 years, etc. This will suit investors based on their cash flow horizons. Rather than limiting the choice to three years, several options will be useful. The plan matures on the set date and the money goes back to the investors.
- Ensure liquidity. Although FMPs are publicly traded, there is no liquidity. If an investor needs cash before the product matures, the market has to be there.
- Ensure good credit quality of the portfolio. Either the portfolio made up of government securities, SDLs and PSU bonds rated AAA.
Enter funds at target maturity
The concept that encompasses all of the ideas mentioned above is a Target Maturity Fund (TMF). These are open funds, unlike FMPs, which are closed. There is a defined maturity date on which the fund matures. Before maturity, liquidity is available. To understand the format of the organization of these funds and the provision of liquidity, let’s look at the two types of structures followed by the TMFs.
One format is called an index fund. An index fund is one that tracks the designated index. The fund manager does not play an active role, just follows the index. In this format, purchases and redemptions are made with the AMC, as in any other fund.
The other structure is the exchange-traded fund (ETF). In an ETF, the fund’s units are listed on a stock exchange, where investors buy and sell. In ETFs, liquidity is generally better than FMPs, but is subject to the presence of exchange counterparties. In an ETF, there is no purchase / redemption from the AMC in the normal course, except for very large batches of purchases called creation units. In addition, you need a mat account and a trading account with a stockbroker to trade ETFs.
For clarity, (a) a fund may not be available as both an index fund (AMC trades) and ETF (exchange trades) and (b) a TMF structured as an ETF follows also the designated index, but is not called a fund index to mean that it can only be bought and sold on the stock exchange.
The quality of the TMF portfolio, at least the ones we have seen so far, is of very high credit quality. The portfolio is made up of either government securities or SDL or AAA rated PSU bonds or a combination of SDL and AAA rated PSU bonds.
What products are available?
In the index fund format, we have IDFC Gilt 2027 Index Fund and Gilt 2028 Index Fund. These two funds have a maturity of approximately six years and seven years. The portfolio includes G-Sec. ICICI Prudential AMC released an NFO called PSU Bond plus SDL 40:60 Index Fund – September 2027. The portfolio consists of 40% AAA rated PSUs and 60% SDL. The YTM of ICICI Prudential PSU Bond plus SDL 40:60 Index Fund – September 2027 (depending on the index) is 6.28%.
In ETFs, there are Bharat Bond ETFs of various maturities; April 2023, April 2025, April 2030 and April 2031. The portfolios are composed of PSU bonds rated AAA. Then there is Nippon India ETF Nifty CPSE Bond Plus SDL – 2024 and ETF Nifty SDL – 2026 with portfolios based on SDL.
There are different TMF maturities available, as mentioned above; choose funds according to your cash flow needs.
(Joydeep Sen is a business trainer and author. His views are his own)