Dynamic Mutual Funds (DMF) and Target Maturity Funds (TMF) are two different types of investment options with distinct 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; while Target Maturity Funds follow a predetermined asset allocation strategy that gradually becomes more conservative as the fund's target maturity date approaches. Also, the DMF manager has the flexibility to change the fund's asset allocation and holdings in response to market trends, while TMF's allocation automatically adjusts over time to reduce risk as investors get closer to their investment goal. But these differences barely scratch the surface when we pit the two against each other. Neeru Seal, Senior Consultant at Alpha Capital, dived deep into the comparison and analysed the finer differences between the two funds, and these were here findings —

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Dynamic Mutual Funds vs Target Maturity Funds: What are Dynamic Mutual Funds?

The Senior Consultant at Alpha Capital explains that Dynamic Mutual Funds have a ‘dynamic’ maturity as well as composition. “These funds have an investment objective of delivering optimum returns in falling as well as rising market cycles. The fund manager of a dynamic debt fund manages the portfolio dynamically with respect to the changes in the interest rates,” she informs.

 

Performance in Dynamic Mutual funds

The tactical approach helps in Dynamic Mutual Funds to maneuver the interest rate movement successfully over different phases to benefit the investors. Neeru says, “These funds have performed better than short term debt and near to long maturity debt funds when interest rate fell, and better than income fund funds, and close to short term debt fund when interest rate rose. Thus, by moving across maturities, they have given commensurate returns across the interest rate cycle.”

 

Who should invest in Dynamic Mutual Funds?

She say that Dynamic Mutual Funds are ideal for market savvy investors who are adept in analyzing interest rate movements. By investing accordingly they can create their own dynamic bond portfolio. 

However, most investors are not savvy enough to make the best calls. For such investors, she says, “Such investors should opt for Dynamic Funds with an investment horizon of around three to five years. Further, investors need a moderate risk tolerance to invest in these funds.”

 

What are Target Maturity Funds?

Target Maturity Funds are passive debt mutual fund schemes, tracking an underlying bond index. Unlike other open ended mutual fund schemes, Target Maturity Mutual Funds have defined maturity dates. On the maturity date, investors holding units of target maturity funds will get the principal amount along with accrued interests. Target maturity funds can be either exchange traded funds or index funds.

 

How do Target Maturity Funds work?

The Senior Consultant at Alpha Capital informs: “As per SEBI regulations, Target Maturity Funds can invest only in Government Securities (G-Secs), State Development Loans (SDLs) and PSU bonds that mirror an underlying bond index. G-Secs enjoy sovereign status. SDLs also enjoy quasi sovereign status because the interest and principal payments come from the State Government’s budget. PSU bonds also enjoy near sovereign status because PSUs are owned by the Government. As a result, the credit quality of target maturity funds is very high.”

Target maturity funds hold the bonds in their portfolio till maturity and roll down the maturities of their bonds. Rolling down maturity means that the maturity or duration of a bond portfolio reduces over time. 

“The yield curve is usually upward sloping, implying that the longer the maturity the higher the yield. For example, the yield of a 5-year bond will usually be higher than yield of a 4-year bond. On the other hand, interest rate risk is directly related to maturity or duration of a bond. For example, a 5-year bond will have a higher interest rate risk compared to a 4-year bond. If you roll down the maturity, you continue to get higher yield on your portfolio, even though your portfolio risk reduces with shortening maturity or duration. This makes Target Maturity Mutual Funds good investment options for investors especially in an environment when interest rates or yields are high and are expected to come down in the future,” she adds.

 

Target Maturity Funds: Salient Points 

The bonds in the Target Maturity Funds’ portfolios pay regular interest (coupons) and the principal (face value) on maturity. The coupons paid by the bonds are re-invested in the fund. So, investors keep accruing interest and benefit from compounding.

“Investors can lock-in prevalent yields over maturity period by investing in Target Maturity Funds, provided their investment tenure matches with the target maturity date. Since the bonds are held till maturity (rolling down maturity), the investor continues to get the yield even if interest rates or yields come down in the future,” she signs off saying.