Ease interest risk with target maturity debt funds, say experts

The Edelweiss fund will invest in an index comprising 50 per cent AAA-rated public-sector unit (PSU) bonds and 50 per cent state development loans (SDLs)
Two target-maturity debt funds are set to hit the market. The new fund offer (NFO) of Edelweiss Nifty PSU Bond Plus SDL Index Fund 2026 opens on Wednesday. This is the first index fund to be launched in the debt space (earlier passive debt funds were all exchange-traded funds, or ETFs). The NFO of another target-maturity fund, Nippon India ETF Nifty SDL-2026 Maturity, will open on March 15.

High credit quality  

The Edelweiss fund will invest in an index comprising 50 per cent AAA-rated public-sector unit (PSU) bonds and 50 per cent state development loans (SDLs).

“Half the portfolio will be in SDLs, which are sovereign debt, and the balance will be in the highest-quality AAA-rated PSU bonds. So, credit risk will be taken care of,” says Radhika Gupta, managing director and chief executive officer, Edelweiss Asset Management. 

The Nippon ETF will invest in SDLs only.

Interest-rate risk mitigated

Interest rates may rise this year due to a variety of reasons: heavy government borrowing, gradual withdrawal of liquidity by the Reserve Bank of India, and possibility of high inflation. Investors in medium- and long-duration debt funds could face mark-to-market losses. One way they can avoid this risk is by investing in a target-maturity fund.

“If you hold your investment in such a fund till maturity, you will get a return equal to the portfolio’s current yield to maturity (YTM) minus the expense ratio,” says Arun Kumar, head of research, FundsIndia.com. Even if rates rise in the interim, investors will be unaffected. The current YTM on the Edelweiss fund is around 6.35-6.4 per cent.   

Index funds offer a few advantages over ETFs. Many retail investors do not have a demat account and hence, are unable to invest in the latter. Systematic investment plans can be run only in index funds. Also, the Indian debt market is not very deep. In extreme market conditions, liquidity tends to dry up. This can cause an ETF’s market price to diverge from its net asset value (NAV). Such deviations erode investors’ returns.

“An index fund offers the assurance that you can sell your units back to the fund house at the NAV,” says Vishal Dhawan, chief financial planner, PlanAhead Wealth Advisors.

Passive funds allow investors to view the portfolio in advance. Fund managers cannot exercise discretion in portfolio formation, so investors know what they are getting into. They also get an estimate of the return they will earn.  

Passive products also carry low costs. Edelweiss will charge an expense ratio of 30 basis points (bps) in its regular plan and 15 bps in its direct plan.

Capital gains will be treated as long-term if these funds are held for more than three years and will be taxed at 20 per cent with indexation. This will boost their post-tax returns, compared to, say, a fixed deposit.

Both indexes are equal-weighted. “This will take care of concentration risk,” says Dhawan.

Time horizon mismatch can be risky  

Investors who don’t have an investment horizon that matches the maturity date of these funds could end up with lower returns than expected over five years.   
Investors entering these funds now will get locked into the current yield for five years. Generally, it is more advantageous to lock in returns for the long-term at the top of the interest-rate cycle (currently rates are moving up from the bottom).

Investors looking for a safe, diversified product that will offer a predictable return over a five-year horizon may opt for these funds.

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