It’s not an apples-to-apples comparison but there are extensive similarities between banking deposits and target maturity funds (TMFs).
The quantum of banking deposits was ₹175 trillion as on 2 December 2022. This is a substantial number, and quite naturally so. The saving populace, particularly in semi-urban and rural belts, have an affinity for bank deposits. At the same time, there is a positive trend of financialization of savings, which is not just in bank deposits but also includes managed investment vehicles such as mutual funds, retirement funds, alternative investment funds, etc. TMFs is an investment product in the mutual fund space that corresponds to the simplicity of bank deposits. Let’s take a look at the similarities between the two.
In TMFs, there is a defined maturity date which is similar to term deposits. For clarity, in the usual open-ended debt funds, while you can withdraw anytime, the fund remains there. It is only your contribution that you are taking back.
In a TMF, the entire fund matures on the defined date and money flows back to the investors. The other basic parameter that defines a bank deposit is the committed rate of return. That becomes a bit tricky in the mutual fund space. As per Sebi regulations, MF products cannot be sold on the basis of expected returns as they invest in the market. As we all know, the market is prone to fluctuations. That is, there cannot be any ‘printed’ rate of return on TMFs which can be compared with deposits. Having said that, there is a high degree of visibility of returns in TMFs.
The portfolio yield-to-maturity (YTM), which is available in the month-end factsheet gives an approximate idea of the interest rate that is being earned on the instruments in the portfolio. The reason for fluctuation of returns in debt funds is that bond prices move every day. The impact may be favourable when market prices move up, and vice versa. However, in a TMF, instruments in the portfolio mature along with the maturity of the product. On maturity, you get back the face value of the bond, which is not dependent on market price movement at that point of time. Hence the portfolio YTM, which is a publicly available data, is not exactly a committed return but gives you an approximation of what you can expect. In TMFs, there is a high degree of correspondence between the portfolio YTM and expected returns as as the securities mature in line with product maturity. Also, there is a portfolio recurring expense, which is publicly available. This may be deducted from the portfolio YTM for a closer perspective.
The other aspect that would be top-of-the-mind for investors is safety. In a bank deposit, there is a committed rate of return. This is not contingent upon the NPA level of the bank. However, in case of mutual funds, the risk is on the investor. If there is any credit accident, the loss will not be borne by the MF. From this perspective, the credit quality of the TMFs available, at least till this point of time, has been top notch.
Portfolios comprise either government securities which are zero default risk, state government securities which also are classified as G-Secs by the Reserve Bank of India (RBI), or AAA rated bonds of Public Sector Undertakings, or a combination of these. Hence, investors need not worry on the safety aspect of TMFs.
Liquidity is relevant; bank deposits can be liquidated at any point of time, but there may be premature withdrawal penalty. TMFs are liquid. If they are in the form of ETFs (exchange traded funds), they have to be sold on the exchange. If they are in the form of an index fund, there is purchase and redemption with the asset management firm like with any other open-ended fund.
Conclusion: Subsequent to interest rate hikes by the RBI, portfolio YTM of funds as well as rates on bank deposits have moved up. In TMFs, as long as you have a horizon of three years or more, you get tax efficiency, which gives you net-of-tax higher returns over bank deposits.
Joydeep Sen is a corporate trainer and author.