Passive debt funds: Hold till maturity for return certainty, say experts

With interest rates expected to rise, staggered investments in target maturity funds will be advisable, say experts

Edelweiss Asset Management Company (AMC) is set to launch the third tranche of its Bharat Bond Exchange Traded Fund (ETF) and Fund of Fund (FoF), which will mature in April 2032. The new fund offer will begin on December 3 and end on December 9. Until now, the fund house offered Bharat Bond ETFs/FoFs with four maturities: 2023, 2025, 2030 and 2031. Their total asset under management (AUM) stood at Rs 36,371 crore at the end of October.

Bharat Bond ETFs are target maturity funds (whose tenure ends on a specific date). And they are passive debt funds that track an index—the Bharat Bond Index of the NSE which holds AAA-rated public sector bonds.

Growing category

Since the launch of the first Bharat Bond ETF in 2019, several fund houses have launched passive debt funds with a target maturity structure, including Aditya Birla Sun Life, Axis, ICICI Prudential, IDFC, and Nippon India. These funds invest in PSU bonds, state development loans (SDLs) and gilts, or a mix of these instruments. The total AUM of the passive debt category stood at around Rs 50,000 crore at the end of October.

Enjoy predictable return

A target maturity fund offers predictable return. “This is a structure that offers a fixed deposit-like experience in an open-end debt fund format,” says Radhika Gupta, chief executive officer, Edelweiss AMC. By looking at the index's yield to maturity (YTM), the investor can know the return he is likely to earn if he holds the fund till maturity (with slight deviation possible due to tracking error). The Bharat Bond 2032 Index has a yield of 6.82 per cent currently.

These funds are transparent. They invest in an index, whose constituents the investor can see before investing.

They are also tax-efficient. The investor becomes entitled to indexation benefit after three years. Post-tax return on the Bharat Bond 2032 index would be 6.33 per cent. In comparison, if a fixed deposit offers 5.4 per cent, and the investor is taxed at 30 per cent (4 per cent cess), he would earn a post-tax return of 3.98 per cent.

These passive debt funds score high on safety. “Since they invest in gilts, CPSE (central public sector enterprises) bonds and state development loans, the investor knows that default risk is minimal or zero,” says Ankur Maheshwari, chief executive officer, Equirus Wealth Management.

They come with low costs. Bharat Bond ETF’s expense ratio is 0.0005 per cent while that of its FoF is 0.05 per cent.

Beware of MTM risk

Those investing in long-tenure funds should be mindful of interest-rate risk. “Be prepared for volatility in net asset values (NAV). If interest rates move up, there will be a mark-to-market (MTM) impact,” says Deepesh Raghaw, founder, PersonalFinancePlan, a Securities and Exchange Board of India-registered investment advisor. However, their interest-rate sensitivity reduces with time.

Lock return now?

By investing in a target maturity fund, investors lock into current interest rates, which is advisable in a falling interest-rate scenario. But should one do so now, when rates appear more likely to rise? A year later a new series of the Bharat Bond ETF could become available that offers a better yield. “The 6.82 per cent rate being offered currently by the Bharat Bond ETF is good in today’s context,” says Maheshwari. Adds Raghaw: “It is impossible to predict the trajectory of interest rates. One doesn't know whether they will rise, by how much, and over what period,” he says. Both suggest making some allocation to this fund now and more later.  

Investors putting their money in a long-tenure target maturity debt fund must bear in mind that they will enjoy certainty of return only if they hold it till maturity.

Target maturity passive debt funds from many fund houses have become available. “To select a fund, match your investment horizon with the fund’s maturity date,” says Raghaw. Investors who may require money in the near future should stay away from them, or select a shorter-maturity fund.