What is a Target Maturity Exchange Traded Fund, and how does it work? Explained

A Target Maturity Exchange Traded Fund (TMETF) is a type of fixed-income ETF that has a predetermined maturity date. These funds hold a portfolio of bonds that all mature in the same calendar year. This means that all the bonds in the portfolio mature around the same predetermined future date, which is the fund's maturity date.

These funds are designed to offer predictable returns when held to maturity. Upon maturity, investors receive the proceeds, which usually consist of their principal amount with interest.

Target maturity funds vs Target maturity ETFs

Target maturity funds (TMFs) are passive debt mutual funds with defined maturity dates that track an underlying bond index. They’re a type of debt fund, structured with a predetermined maturity date in line with the maturity of the bonds in their portfolios. TMFs are basically open-ended debt funds with a specific maturity date.

While both TMF and TMETF invest in bonds that mature in a specific year (or around the same time), they differ mainly in how investors buy and sell them.

Units of TMFs can be purchased or sold at the end-of-day net asset value (NAV). On the other hand, target maturity ETFs can be traded throughout the day on an exchange like stocks. TMFs may also have higher fees and less frequent portfolio disclosures (monthly/quarterly), due to NAV, while target maturity ETFs offer lower costs and greater transparency.

How do Target Maturity ETFs work?

A Target Maturity ETF passively tracks an underlying bond index, usually one that holds high-quality securities like Government Securities (G-secs), State Development Loans (SDLs) and Public Sector Undertaking (PSU) bonds. These ETFs hold the bonds in their portfolio till maturity.

TMETFs only invest in high-quality bonds that have a sovereign or quasi-sovereign status to create a high-credit-quality portfolio.

With a specific maturity date, the TMETF is automatically redeemed, and investors receive the principal amount (with interest) at maturity. Investors can also sell before the maturity date, but that exposes them to short-term losses from interest rate fluctuations.

Benefits of Target Maturity ETFs

A Target Maturity ETF may be suitable for you if you’re a conservative investor who is saving for a specific financial goal with a defined timeline, as they have a maturity period. These funds offer stable and predictable returns to investors if held until maturity. However, remember that these returns are not guaranteed.

• High-quality investments like G-Secs and SDLs.
• Can buy or sell on an exchange like shares.
• Low credit risk.
• Aligning investments with financial goals with timelines.
• Typically have a lower expense ratio as compared to actively managed funds.

Risks of investing in Target Maturity ETFs

• If you exit early, interest rate fluctuations can cause short-term losses.
• Fund managers have limited flexibility, which means there is limited scope for portfolio adjustments.
• While many target maturity ETFs focus on safe government and state development bonds, some may also hold corporate bonds, which expose investors to credit risk.
• As these are a relatively new investment class, there isn’t long enough history to evaluate performance in different market cycles.
• Liquidity on the stock exchange can vary.

Example of Target Maturity ETFs

Axis Mutual Fund recently filed draft papers with SEBI for its two new target maturity ETFs, the Axis Crisil-IBX AAA Bond NBFC – Sep 2028 ETF and Axis Crisil-IBX AAA Bond Financial Services – Jun 2029 ETF.

These open-ended funds are passively managed target-maturity exchange-traded funds (ETFs) designed to track their respective CRISIL-IBX AAA Bond indices.

Both of these funds are part of Axis Mutual Fund’s expanding lineup of target maturity debt ETFs, offering predictable maturity and returns with exposure to high-quality AAA-rated issuers.