TMFs are relatively safer and offer visibility of returns.
Target maturity funds or TMFs have a defined maturity date, arguably good portfolio credit quality and they come with a range of maturities to choose from.
Of late, TMFs have become popular due to attractive yields. While TMFs are good options for MFDs/RIAs to consider for debt allocation, here are a few aspects that should be kept in mind:
Matching the maturity and your cash flow
Ideally, MFDs/RIAs should recommend TMFs if time horizon of clients matches the fund maturity. Reason: net returns may differ if investors redeem it prematurely. For instance, if an investor invests in a 7-year TMF and exits after 3 years, he will get returns based on the prevailing yields, which may not be in line with fund’s expected returns. Since so many maturity options are available, your clients can easily do a cash flow matching.
TMFs are liquid and exit is not an issue. TMFs are available in both ETFs and index route. While investors may have to bear impact cost in ETF structure, index and FOFs route is more liquid. However, FOFs route will be expensive but still better than ETFs in terms of liquidity.
Please note that market makers offer liquidity in ETFs but AMCs are responsible to ensure adequate liquidity in index structure.
Portfolio YTM and expense level
You may do a ballpark check on the YTM of TMF. While it does not guarantee a particular return, it gives a good visibility on what you can expect. Recurring expenses may be subtracted from the YTM but usually TERs of TMFs are very reasonable.
Variability in returns
This is a function of holding period and market movement. The longer you hold, the better. For instance, if an investor invests in a 7-year TMF and exits after one year, he may benefit if prevailing interest rates have come down. Returns will be adversely impacted if yields move up. If you are there for say 6 years, you have the cushion of 6 years of accrual. Moreover, over a long period, market cycles play out the ups and downs. If you exit after say 3 years, it is somewhere in between. To reiterate, the portfolio YTM, or net of expenses YTM, is not a commitment on returns but a proxy, which gives us a perspective on what to expect from the fund.