Why target maturity funds are a good option for predictable returns

Think debt funds are boring? Well, in the case of target maturity funds (TMFs), boring is good. TMFs are passive investment products that take the guesswork out of interest rates as their maturity date is aligned with that of the bonds in their portfolio. “This ‘roll-down’ strategy means short-term mark-to-market fluctuations from rate changes are gradually neutralised as the bonds converge to par at maturity,” says Sirshendu Basu, Head-Products, Bandhan AMC.

Unlike traditional debt funds, which are actively managed and so exposed to duration risk based on interest rate movements, TMFs offer predictability of returns if held till maturity. Duration risk, also called interest rate risk, is movement in the value of the bond in response to changes in interest rates (a rise in rates reduces bond prices and vice versa). The icing on the cake is a lower expense ratio considering these funds are managed passively. Investors get the expected amount if the company or the government that has issued the bond doesn’t default.

“However, TMFs lose their edge when investors exit early if rate hikes happen just before maturity, or when markets rally, because unlike active funds, they don’t capture big mark-to-market gains,” says Manish Kothari, CEO and Co-Founder, ZFunds, a platform for investing in mutual funds. The key question is: How can an investor make the best use of TMFs?

Credit Check

Most TMFs follow an index. So, investors must look at the index composition and credit ratings of securities—such as AAA-rated PSUs or high-quality corporates—in the benchmark. “At present, TMFs are typically restricted to AAA and above. Thus, credit risk is marginal. In case the rating of a particular paper is cut, the fund is supposed to exit it within a stipulated price,” says Kaustubh Gupta, Co-Head, Fixed Income, Aditya Birla Sun Life AMC.

One should watch out for bonds of highly leveraged companies. “In today’s scenario, portfolios that have microfinance institution/non-banking financial company exposure would be the ones to be wary of. Government and state development loans are relatively safer,” says Vivek Banka, Founder, GoalTeller, a Sebi-registered investment advisory firm.

For fund houses, building a robust portfolio requires a systematic approach to understand how interest rates move and impact investments. Murthy Nagarajan, Head-Fixed Income, Tata Mutual Fund, says they factor in different variables affecting interest rates. These are weighted to arrive at a composite score based on which the duration of the portfolios is created. The fund houses also have their own checks and balances. For example, Tata Mutual Fund has built a framework to evaluate companies, using external ratings only as a reference. It also applies a corporate governance filter. Only companies that meet these standards qualify.

One of the best features of TMFs is that they give investors certainty about what they will get on maturity by locking them into a fixed yield-to-maturity (YTM). The NAV moves up or down in between but, closer to maturity, settles near the locked-in yield. This makes TMFs simple, predictable, and useful for goal-based investments. “The returns from actively managed debt funds, on the other hand, are dependent on the manager’s skill in changing duration and capturing mark-to-market gains when interest rates fall. Active funds can beat TMFs but also carry higher volatility and risk,” says Kothari. Investors must compare a TMF’s locked-in yield with the track record of active funds and choose based on their risk appetite.

Laddering Like A Pro

One way to make the best use of TMFs is ‘laddering’, that is, investing in funds with different maturity dates so that a part of the portfolio matures every few years and gives steady cash flows. This also helps investors average out the interest rate cycle. “The ladder should match the investor’s cash-flow needs—shorter TMFs (three to five years) for near-term goals and liquidity, and longer TMFs (five to seven years) for higher yields in the future,” says Kothari.

Too much exposure to long maturities boosts yield but creates reinvestment uncertainty later, while too much in short maturities lowers yield but improves flexibility. Reinvestment risk means having to reinvest cash flow from an investment at lower rates.

A balanced ladder across tenors gives steady cash flows as well as higher yields, say experts. “For example, a retiree needing steady liquidity could ladder TMFs every two years. An HNI can tilt towards longer-dated TMFs for higher yields while opting for some short-duration TMFs for opportunistic redeployment,” says Basu.

However, recent tax changes have hurt TMFs. The government now taxes all debt fund profits at the income tax slab rate, no matter how long the holding period. “TMFs had a huge tax advantage with 20% long-term capital gains tax after indexation if held for over three years. The indexation benefit is gone now, making TMFs less attractive,” says Vaibhav Porwal, Head of Investments, Dezerv, a wealth management platform.

Behavioural Pitfalls

TMFs are designed to be predictable but during periods of market volatility, investors may be tempted to cash out to protect their capital. This may convert temporary mark-to-market losses into permanent capital erosion. Another bias that can affect returns is overweighting recent performance, for example, entering after yields have spiked. Some investors also try to time interest rate movements.

To reduce these biases, the funds educate investors about why they should hold till maturity, explaining that everyday mark-to-market volatility doesn’t affect final returns.

“Goal-based investing can align the fund’s maturity with financial milestones. Finally, it’s important to avoid reacting to noise, such as intra-quarter interest rate or credit events, unless the fundamentals of the investment have changed,” says Basu.

Portfolio Fit

Cash flow stability makes TMFs a good fit for retirees. “They help retirees invest in longer-term bonds and lock in yields without worrying about interest rate risks, ensuring returns closer to the target while providing liquidity,” says Banka of GoalTeller.

TMFs with shorter maturities (three to five years) can provide predictable income aligned with cash flow needs and minimal reinvestment risk, while laddering can ensure regular payouts.

Target date funds, which automatically adjust asset allocation as you approach a specific goal, also work well for retirees. “These are ideal for investors who want a ‘set it and forget it’ approach to long-term investing, particularly for retirement planning. These funds are common in the US but still evolving in India,” says Porwal.

For high-net-worth individuals, TMFs ensure interest rate risk control, diversification, and cash flow visibility in a volatile macro environment, and when combined with active strategies, balance yield, risk, and liquidity. Overall, they offer the “fixed deposit of mutual funds” proposition: low cost, transparency, and predictability.

Timing the Entry

“TMFs are a great instrument when you want predictability of returns. One can enter a TMF if the estimation is that the interest rate cycle is near the top,” says Suresh Sadagopan, founder, Ladder7 Financial Advisories. “Our house view remains tilted towards short-duration and accrual strategy, rather than long duration, where volatility risk is higher,” says Porwal.

Accrual strategy focuses on earning steady income from interest payments, holding securities till maturity. In contrast, a duration strategy seeks to gain from fluctuations in bond prices due to interest rate changes.

With inflation expected to stay under control in the near future, real returns from fixed income are attractive and so TMFs could be a good way to lock into current yields. Since bank fixed deposit rates have stopped going up and the RBI is holding rates steady, this is a good time to invest in TMFs for slightly better returns and liquidity options matching your goals.

Laddering balances safety and returns, reduces reinvestment risk, and makes TMFs an important part of a fixed-income portfolio. “Unless interest rates move up, which seems unlikely in the near future, especially with the impact of the US tariffs, investors would be best placed to invest in two to three-year TMFs with reasonable credit quality to get decent yields with low interest rate risks,” says Banka.

By investing now, investors can lock into the prevailing YTM, which captures today’s elevated rates before the next rate cycle begins.

TMFs work best when their maturity is matched to the investor’s time horizon, ensuring predictability of returns and minimising reinvestment risk. For instance, those with near-term needs—such as expenses in the next two to three years—can consider TMFs maturing in 2026–27. Investors with medium-term goals, like education or a major purchase, may opt for 2029–31 maturities to secure higher yields while managing volatility.

For long-term objectives such as retirement, longer-dated SDL (state development loans) or G-Sec (government securities) TMFs provide stability and steady compounding. “Match investment horizon to TMF maturity to maximise risk-adjusted returns,” says Basu of Bandhan AMC.

If active funds are roller coasters, TMFs are a scenic Ferris wheel: slower, steady, and offering a clear view of financial goals. You lock in yields, enjoy the calm ride, and arrive predictably at your destination—proof that patient investing can be quietly rewarding.