Domestic investors got a taste of TMFs for the first time in 2019 with the launch of Bharat Bond ETF series 2023 and 2030. Two additional funds were offered in 2020- Bharat Bond ETF Series 2025 and 2031. This was the first time that the portfolio was offered to debt fund investors. of pristine credit quality bond Packaged in a low cost idle vehicle with defined maturity.
A pack of AAA-rated PSU bonds offered the comfort of safety amid credit-led mishaps in debt funds. The index avatar provided a degree of transparency about what would be included in the fund portfolio, eliminating the discretion of the fund manager. The expense ratio was much lower than the fees charged by actively managed open-ended debt funds. The pre-determined maturities allowed some degree of predictability of returns and put a lid on interest rate risk, yet provided easy liquidity by facilitating exit at any time. This potent cocktail makes it a compelling option for investors looking for a safer route to earning decent yields. The big splash made by initial offerings opened the door for new, diversified TMFs. After this the process of launch started.
AMCs now offer Plain-Vanilla Gilt Index TMF (inclusive of government securities) and SDL Index TMF (State Development Debt). Investors also have combo TMF in the form of PSU Bond Plus SDL Index Fund and GSEC Plus SDL Index Fund. Additionally, Combo Funds are packed in different ratios like 35:65, 50:50, 60:40, 70:30 and various permutations of these. Thirty-six funds are already active in this area, barely three years after the first one went out the door.
Many more are awaiting regulatory approval. This will introduce investors to new flavors. Add to this the different maturity profiles for the period from 2023 to 2032 and beyond, with funds catering to multiple maturity buckets. The plethora of options are sure to confuse investors. How does one solve this dilemma? A natural habit for many people is to opt for higher yielding TMFs.
The prevailing returns in these funds range from 6.4% on short maturities to 7.7% for longer tenures. While the yield is only indicative, investors can expect a return close to this yield minus the fund expense ratio. But choosing TMF only on the basis of returns is not the right way. Kirtan Shah, Founder, Credence Wealth Advisors insists, “Don’t invest in long maturity funds just to get 10-20 bps higher yield. There may be some opportunity cost in the incremental time risk.”
Experts recommend that investors first identify the right maturity bucket. Investors should align their own time horizon with the duration of the fund. For example, if you have cash needs 3 and 5 years from now, you can split your capital into two target maturity funds with matching periods. Others may identify a different set of maturity buckets. “Invest in a TMF that matures a few weeks before or around the same date as the target date for your planned outlay,” said Amol Joshi, Founder, PlanRupee Investment Services. Experts are of the view that the choice of the underlying bond- Gilt, PSU or SDL and any combination thereof is largely unimportant from the security point of view. All these instruments claim superior credit quality.
To be sure, plain-vanilla central government bonds always rank highest on this front. But SDL and PSU are not far behind in terms of bond quality. SDLs are loans issued by state governments to meet their fiscal deficit. Although there is no explicit sovereign guarantee on SDLs, the risk of default is almost nil under the RBI-led repayment mechanism. The central bank has the power to make repayments to the SDLs out of the central government’s allocation to the states.
It maintains a reserve fund to meet contingent liabilities arising out of borrowings by state undertakings. At times, loans taken by state governments with unstable financial conditions or rising fiscal deficits can trade at high spreads. But it usually ends in the long run. AAA-rated PSU bonds rank only slightly lower than SDLs on credit quality. Still, corporate bonds have the highest credit ratings, albeit not as comfortable as a sovereign guarantee.
Shah remarked, “Even though credit profile is not an issue in these instruments, theoretically, AAA PSU bonds would rank lowest on credit risk, followed by SDLs and then gilts.” Experts say that investors can safely choose TMFs with any combination of these instruments. “While credit quality varies somewhat between these instruments, choosing one over the other is not likely to materially alter the risk profile,” Joshi stresses. Once you zero in on the specific maturity bucket, investors can make their choice based on the prevailing return and expense ratio. Considering the minor differences in credit profiles, the return on funds with different underlying instruments will differ even for the same maturity.
Within the maturity bucket, if two funds with similar expense ratios are driving different yields, go for the fund with the higher yield. “If you are finding material difference in yield, choose PSU bonds or SDL-led TMFs over gilt-based TMFs,” argues Shah. Avoid choosing a fund if its expense ratio in the maturity bucket is very high as compared to others. If investing through index ETFs, keep liquidity and spreads in mind. Index funds are a better option to avoid the issues of mis-pricing. Lastly, stay invested till maturity to negate interest rate driven price swings.