In light of the current interest rate environment, investors can benefit from higher rates while reducing risks related to market swings by investing in a variety of debt products. The optimum opportunity to invest in fixed income is when interest rates are rising, while the Indian market has been strong throughout global volatility, the Reserve Bank of India (RBI) has raised the repo rate six times in a row this financial year. Considering the 250bps interest rate hike by RBI, the attraction of fixed-income investments has become attractive for debt instruments such as fixed deposits of banks. In light of rising interest rates, where should investors invest? Let's gather advice from various industry experts on Dynamic Bond Funds vs. Target Maturity Funds vs. Bank FD.
We are nearing peak of rates. At this point we believe dynamic funds score well over target maturity and FD. Given flat curve both (target mat and dynamic )have similar earring yield but dynamic funds can increase duration and deliver superior risk adjusted returns in falling rate scenario as it emerges over next 18m.
Dynamic bond funds change portfolio maturity as per the interest rate scenario whereas Target maturity funds & bank FDs the maturity date is fixed.
With Interest rates at relatively high levels, investors with tenure of around 3 years may go with dynamic bond funds as the possibility of capital gain is higher when interest rates starts to ease (but this comes with interest rate risk).
Investors looking for stable returns may go with Target maturity funds as they provide liquidity with possibility of capital gains compared to Bank FDs but with some short term volatility.
Based on current global trends, It is advised to pay attention to two things when thinking about your investment strategy. Firstly, global inflation is still present, though it's gradually easing. Secondly, some pockets of inflation are still high, which means interest rates may not have peaked yet. However, we're moving closer to the end of this cycle.
Taking all this into account, it's a good time to start allocating some of your funds into fixed-income investments. If you already have a fixed-income allocation, it may be worth considering a slightly longer duration for your investments. This strategy can help you take advantage of the current interest rate environment and potentially generate higher returns while minimizing risks.
Considering the current interest rate scenario, it's advisable to invest in a combination of Target Maturity funds and Dynamic Bond Funds. This strategy can help investors take advantage of rising interest rates while minimizing risks associated with fluctuations in the market.
Target maturity funds are passive investment structures that allow investors to capture almost peak interest rates. With target maturity funds, there is a defined maturity date, providing a high level of certainty regarding interest rates.
On the other hand, dynamic bond funds act as strong complements to target maturity funds due to their flexible mandate. The fund manager can purchase bonds with two to three-year maturities, and if interest rates rise, they can purchase bonds with five to seven-year maturities. Additionally, they can toggle between corporate and government bonds as needed.
Targeted Maturity Funds (TMFs) are debt funds that are passively managed and are designed to mirror the performance of a specific bond index. These funds are becoming popular among conservative investors. The asset management company (AMC) invests not in just one bond but in a portfolio of bonds, increasing the portfolio's diversity.
These investments have a known maturity. Investors that purchase target maturity funds lock in an interest rate and stand to gain from it regardless of the state of the economy as a whole, provided the funds are kept until maturity. Target maturity funds are open-ended and have no lock-in period, so investors can withdraw their money at any time. They do not require investors to commit capital for a set length of time, but the Buy and Hold (to maturity) approach is still advised.
Since TMFs are not actively managed, the expenditure ratio is typically between 10 and 50 basis points. TMF is designed to track bonds that pay interest (coupons) on a consistent basis and are included in the index. The fund reinvests the bond coupons and gains by compounding. The original investment and all interest accrued is returned to the investors on the maturity date.
Target maturity funds offer better post-tax returns if they are held till maturity. But if they are held for a shorter horizon they may offer returns that are similar to fixed deposits.
With the RBI raising rates drastically over the past few cycles to rein in inflation, bond yields have spiked across the yield curve. In a scenario like this, it certainly makes sense to invest into a target maturity fund with a residual maturity of 4-5 years, because one can expect a return of around 7.4% to 7.5% CAGR from them.
Since TMF’s track bond indices, they invest almost entirely into GILTs and SDLs, thereby eliminating the possibility of credit shocks. TMF’s are passive and follow a roll down strategy, meaning that they basically do not take active credit or duration calls within their portfolios. An investor who buys in today and holds the fund until its maturity can be reasonably well assured that they will earn the YTM that they are buying into, if they hold it until maturity. Besides, TMF’s are open ended and allow access to capital, which is why they score over other roll down funds like FMP’s.
A TMF can be expected to beat current FD rates both on a pre and post-tax basis in the current environment, as they offer indexation benefits which FDs do not. When it comes to dynamic bond funds, we’re not very optimistic as it’s exceedingly difficult to take duration calls in an environment like this, so we aren’t entirely comfortable with an active duration management strategy especially when such attractive returns can anyways be achieved from a TMF.
Across these 3 options, the comparison is not exactly apples to apples, however the current environment compels investors to look at the fixed-income market favourably. While interest rates and inflation have eased globally, there is still some way to go.
Targeted Maturity Funds (TMFs) are debt funds that are passively managed with pre-defined maturities. As an investor can lock-in an attractive interest rate with a TMF and simply lock it. TMFs are riskier than bank FDs but still come with reasonable visibility of returns. Dynamic Bond Funds (DBFs) on the other hand are actively managed and play on changing interest rates. They can be an effective way to balance and hedge your TMF investments.
However, look at these options only after understanding them, underlying fees and taxation.
The last two years have been marked by high volatility and rapid changes in policy direction at a global level. Rate hikes have been unparalleled in both quantum and velocity. And while the dust may settle for a few months, it is likely for a reversal in policy to start by the end of the year.
Dynamic bond funds would be our preferred choice given the fact that macro cycles have been shorter in duration. Professional management and agility offered by them are just what’s needed to make the most of the current environment. A portfolio built by investing in a bunch of target maturity funds or by laddering bank FDs limits ones ability to quickly skew duration of the portfolio without the addition of more capital, especially when trying to reduce duration.
Dynamic Bond Funds are mutual funds that invest in a diversified portfolio of bonds with varying maturities and credit ratings. These funds can provide higher returns than Bank FDs, but they also carry higher risks. They are suitable for investors who are willing to take on moderate to high risks for the potential of higher returns. In the current interest rate scenario in India, where interest rates are expected to remain constant for some time and decline future, dynamic bond funds may provide better returns than Bank FDs.
Target Maturity Funds are also mutual funds that invest in a diversified portfolio of bonds, but with a specific maturity date. They are suitable for investors who want to lock in their investment for a specific period and are looking for a predictable return. Target Maturity Funds can provide returns that are slightly higher than Bank FDs, but lower than dynamic bond funds. They are suitable for conservative investors who want to invest in fixed-income instruments and have a low-risk appetite. In the current interest rate scenario, Target Maturity Funds may not be the best option.
Bank FDs are low-risk investment option that provides a fixed rate of interest for a specific period. They are suitable for investors who want to invest their money for a fixed period and earn a predictable return. Bank FDs are ideal for conservative investors who want to invest their money in a safe and secure investment option. However, in the current interest rate scenario in India, where interest rates are expected to remain constant and decline further, Bank FDs may provide moderate returns with safety.
In summary, the choice between Dynamic Bond Funds, Target Maturity Funds, and Bank FDs will depend on your investment goals and risk appetite. In the current interest rate scenario in India, dynamic bond funds may provide better returns than Bank FDs, but they also carry higher risks. Target Maturity Funds may not be the best option, and Bank FDs may provide moderate low risk returns. It's important to consult with a financial advisor to determine the best investment option for your specific situation.
Due to most banks increasing their FD rates, investing in FD is a safe and reliable option for generating predictable returns for very conservative investors. However, the interest earned is subject to taxation at the maximum marginal rate.
TMFs, which are passive debt mutual funds that invest in government securities, state development loans, PSU bonds, or a combination of these, offer higher predictability and a tax benefit after three years from the date of purchase. These funds are suitable for investors with a 3-year or longer investment horizon.
For debt investors seeking more aggressive investment options, dynamic bond funds are an excellent choice. These funds invest in both short and long-term debt securities, although returns for a shorter duration can be more unpredictable. However, they tend to perform well in a declining interest rate environment. Suitable for a 3-to-5-year time hoirzon.
The option you choose would depend on the time horizon you have in mind. In the current market scenario fixed deposits would be the first pick followed by Target Maturity & Dynamic Bonds.
While the RBI has a neutral stance, there are global concerns around debt and dynamic bonds that hold a higher risk in comparison to FDs.
For investors with visibility on time horizon for the investment into fixed income products, target maturity funds offer a strong value proposition. Approximate matching of the investment period with the product's target maturity could be a straightforward way to begin. For longer term fixed income allocators, select dynamic bond funds with credible frameworks and fund management teams could offer relatively higher risk-adjusted returns over the longer period. The scope for active management here offers incremental performance. For investors seeking to maintain an accessible corpus for the very near term or for a goal that requires returns to be linear, bank fixed deposits offer great value.
With the Bank FD rates moving up consistently with some prominent banks even offering 7.75% for senior citizens, it makes sense to lock up at this rate. However there is a possibility of rates rising another 50bps in the next 6 months. Target Maturity Funds is good for others since it offer close to 10 year bond yields with indexation & tax benefits.