Dynamic Mutual Funds (DMF) and Target Maturity Funds (TMF) are two different types of investment options with different characteristics and purposes. Broadly speaking, Dynamic Mutual Funds are actively managed, meaning that the fund manager actively makes investment decisions based on market conditions and the fund’s objectives; Target maturity funds, on the other hand, follow a predetermined asset allocation strategy that gradually becomes more conservative as the fund approaches the target maturity date. In addition, the DMF manager has the flexibility to change the fund’s asset allocation and holdings in response to market trends, while the TMF’s allocation automatically adjusts over time to reduce risk as investors advance towards their investment objective. But these differences hardly scratch the surface when we pit the two against each other. Neeru Seal, senior consultant at Alpha Capital, delved deeply into the comparison and analyzed the subtler differences between the two funds. These were the following results:
Dynamic Mutual Funds vs. Target Maturity Funds: What Are Dynamic Mutual Funds?
The senior consultant at Alpha Capital explains that dynamic mutual funds have both “dynamic” maturity and “dynamic” composition. “The investment objective of these funds is to achieve optimal returns in both falling and rising market cycles. “The fund manager of a dynamic debt fund dynamically manages the portfolio in response to changes in interest rates,” she says.
Performance in Dynamic Mutual Funds
The tactical approach helps Dynamic Mutual Funds to successfully maneuver interest rate movement through various stages to the benefit of investors. Neeru says, “These funds have outperformed short-dated and near-dated bond funds when rates fell, and outperformed income funds and near-dated bond funds when rates rose.” By moving across maturities , they have delivered decent returns throughout the interest rate cycle.”
Who Should Invest in Dynamic Mutual Funds?
She says Dynamic Mutual Funds are ideal for market-savvy investors who are good at analyzing interest rate movements. By making appropriate investments, you can build your own dynamic bond portfolio.
However, most investors aren’t smart enough to make the best decisions. For such investors, she says: “Such investors should opt for dynamic funds with an investment horizon of around three to five years.” In addition, investors need a moderate risk tolerance to invest in these funds.”
What are Target Maturity Funds?
Target Maturity Funds are passive mutual funds for debt securities that track an underlying bond index. Unlike other mutual fund programs, Target Maturity Mutual Funds have set maturity dates. On the Maturity Date, investors holding Shares in Target Maturity Funds will receive the principal amount plus accrued interest. Target funds with maturity can be either exchange traded funds or index funds.
How do Target Maturity Funds work?
The senior consultant at Alpha Capital informs: “Under SEBI regulations, Target Maturity Funds can only invest in government securities (G-Secs), government development loans (SDLs) and PSU bonds that reflect an underlying bond index.” G-Secs enjoy sovereign Status. SDLs also enjoy quasi-sovereign status as interest and principal payments come from the state government budget. PSU bonds also enjoy near-sovereign status as the PSUs are owned by the government. As a result, the credit quality of the target term funds is very high.”
Target maturity funds hold the bonds in their portfolio to maturity and extend the life of their bonds. Rolling down maturity means that the maturity, or duration, of a bond portfolio decreases over time.
“The yield curve is typically sloped up, meaning that the longer the term, the higher the yield. For example, the yield on a 5-year bond is typically higher than the yield on a 4-year bond. On the other hand, interest rate risk is directly related to the term or duration of a bond. For example, a 5-year bond has a higher interest rate risk than a 4-year bond. When you extend maturity, you continue to earn higher returns from your portfolio, even as your portfolio risk decreases as maturity or duration decreases. This makes Target Maturity Mutual Funds a good investment option for investors, particularly in an environment where interest rates or yields are high and likely to fall in the future,” she adds.
Target Maturity Funds: Key Points
The bonds in the Target Maturity Funds’ portfolios pay periodic interest (coupons) and principal (par value) at maturity. The coupons paid by the bonds are reinvested in the fund. Investors therefore continue to receive interest and benefit from compounding.
“Investors can lock in prevailing returns over time by investing in Target Maturity Funds, provided their investment horizon matches their target maturity date. Because the bonds are held to maturity (rolling down maturity), the investor continues to receive the yield even if interest rates or yields fall in the future,” she concludes.
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