iFund- Understanding of Target Maturity Bond Fund

2019-03-19 10:20
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Hong Kong investors have always favored interest-bearing products. For stable investors, bonds are the most appropriate choice. However, the interest rates of investment-grade bonds are limited, and the liquidity of high-yield bonds is low. Moreover, the minimum subscription amount of direct bond is generally as high as 200,000 US dollars, causing many investors hesitated in joining this market.

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Hong Kong investors have always favored interest-bearing products. For stable investors, bonds are the most appropriate choice. However, the interest rates of investment-grade bonds are limited, and the liquidity of high-yield bonds is low. Moreover, the minimum subscription amount of direct bond is generally as high as 200,000 US dollars, causing many investors hesitated in joining this market.

What is target maturity bond fund?

Recently, the concept of  target maturity strategy is introduced, in which the target maturity bond fund is one of the options. Target maturity bond fund is a bond fund that has a maturity date. The goal of such funds is to dodge the fluctuating price risk by holding the bonds until maturity date. When the fund expires, the fund will be dissolved and the principal will be returned to the investor.

Unlike high-yield bonds, the target maturity bond fund has a clear investment life. From the perspective of investors, the target maturity bond fund can clearly reflect the investor’s own investment period, avoiding to bear too much or too little risk. This makes it suitable for the investors who have short or medium term goals, such as property ownership plan, fertility plan, and education plan etc. In addition, target maturity bond funds can lock in the yield to maturity, which are suitable for investors who are worried that the stock market will be fluctuating in the next few years, or are waiting for interest rate hikes.

From the product perspective, a clear maturity date limits the fund manager’s exposure to excessive risk. As long as the bond is held until the maturity date, and the bond does not default, investors can obtain the agreed remuneration. Therefore, holding various bonds through a fund can reduce the default risk of just investing in a single bond. On the other hand, the high-yield bonds may have huge trading spreads when there is liquidity risk in the market. The target maturity bond funds limit the redemption date and raise the requirements for redemption, so it can prevent the fund managers to sell the bond at a low price due to redemption pressure.

Risks of target maturity bond funds

A target maturity bond fund faces credit risk because there is no guaranteed interest rate nor a guaranteed principal return. Although it is in an interest rate hike cycle currently, the benchmark interest rate is still below investor expectations. As a result, most of the target maturity bond funds are allocated with high-yield funds and emerging market bond funds to increase fund’s yields. Also, since the bonds will not expire on the maturity date of the fund simultaneously, the fund need to bear greater risks in the early stage in order to maintain a stable return rate.

Finally, investors cannot ignore that the returns will be reduced due to the fees. When investors calculate the expected return rate, they need to deduct the subscription fees and management fees first.

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