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Constant duration strategy vs. target maturity strategy: Which is right for predictable returns?
November 6th, 2023 Latest Blogs
A solid investment plan is crucial in today's uncertain stock market. Debt funds are like steady anchors in your investment portfolio, especially when volatile stock prices are high. Two shine among various debt fund strategies—constant duration and target maturity funds. Let's explore how they can be your financial allies.
Constant duration strategy
Constant duration funds focus on maintaining a consistent duration for their portfolio within a specified range. Duration, a critical metric in fixed-income securities, indicates a portfolio's sensitivity to interest rate changes. Longer durations make a portfolio susceptible to interest rate shifts, influencing bond prices inversely.
Investors opt for constant-duration funds when seeking to park their funds in shorter-duration categories or when strategically navigating the interest rate cycle for potential gains. Shorter-duration funds, such as ultra-short and low-duration categories, are less sensitive to interest rate shifts, necessitating minimal intervention.
Empirical data highlights that committing to long-duration funds and holding them for an extended period curtails return volatility. This strategy allows investors to weather market fluctuations effectively, making longer-duration funds a viable option for those with a longer investment horizon.
Target maturity strategy
Target maturity funds invest in fixed-income securities with a specific maturity date, aiming to provide investors with predictable income if held until maturity. These funds often concentrate on the period of the yield curve where bond interest rates are highest.
Investors employing a target maturity strategy can either sell the fund before maturity, benefiting from roll-down returns as the fund moves down the yield curve, or opt for a buy-and-hold approach to secure returns close to the fund's yield to maturity (YTM).
While target maturity funds mitigate duration risk through a buy-and-hold strategy, they are particularly advantageous when interest rates rise, enhancing reinvestment returns. However, reinvestment returns may reduce the final returns during falling yield periods compared to YTM at the time of purchase.
Making informed investment choices
Selecting the right debt mutual fund category is crucial to diversifying an investment portfolio effectively. Factors such as time horizon, financial goals, and the prevailing macroeconomic environment should guide the investment strategy.
The constant duration and target maturity strategies offer unique benefits in debt funds. Stable duration funds allow strategic navigation of interest rate fluctuations, providing a degree of control over investment outcomes. On the other hand, target maturity funds ensure more predictable returns, catering to investors seeking stability and assurance.
Investors should conduct comprehensive due diligence before making investment decisions, considering the empirical data and their financial objectives. Well-informed choices can pave the way for a successful and rewarding investment journey in this dynamic economic landscape.
Disclaimer: This article is for informational purposes only and does not constitute financial advice. Readers should consult with a financial advisor before making any investment decisions.
Chakravarthy V. Cofounder and Director, Prime Wealth Finserv
