Target Maturity Funds (aka Defined-Maturity Bond Funds)

A primary difference between bond funds and individual bonds is that individual bonds have a maturation date when the face value of the bond is distributed to the bondholder as a return of the principal. By contrast, most bond funds are perpetual securities. When bonds mature within a fund, the bond manager reinvests the proceeds into other bonds. Bond funds can be sold like stocks, but there is a risk that the sale price will be less than the purchase price. In other words, bond funds do not have a face value, so you cannot know what the redemption value of the fund will be until it is sold. Bonds, on the other hand, do have a face value, so you will know what you will receive when the bond matures if the bond issuer does not default.

Target maturity funds (aka defined-maturity bond funds) are designed to mimic individual bonds by having a termination date when the bonds have all matured and the net asset value is distributed to the shareholders. They were 1st launched in 2010. The year of termination is listed in the name of the fund and in the prospectus. Examples:

These funds may appeal to people who desire professional management, a return of their capital at a specific date, and who do not want to own individual bonds.

These funds hold a portfolio of bonds set to mature near the fund's expiration date. Near the termination date, the proceeds of bond maturities are not reinvested in other bonds, but are invested in cash-equivalent securities, so that cash can be distributed to shareholders on the expiration date, when the fund will be liquidated, and the proceeds will be distributed to shareholders. Thereafter, the fund will cease to exist. However, shares can be sold prior to the termination date.

The allocation to cash within the fund will cause yields to drop in the final year.

Although the turnover rate of the securities within the fund is low, there is some turnover due to bonds being called, credit outlook changes, and inflows or outflows from the fund. This turnover may generate some transactions taxable to the shareholder, especially if it is organized as a mutual fund or a closed-end fund.

Target date funds are similar but differ from target maturity funds in that target date funds have a more aggressive investment objective in the early years, buying more stocks than bonds for more growth. As the target date is approached, the investment objective becomes more conservative, buying safer securities, usually bonds, to preserve capital and to lower risk.

A drawback of target maturity funds is that the final value of the fund is not knowable before the termination date, unlike a bond that pays face value. However, the NAV at termination usually exceeds the NAV at inception, though rarely it may be less. Capital gains or losses may result from differences between the purchase price and the sale or liquidation value of the fund. The NAV will fluctuate with changes in the value of the portfolio and changes in the share price, which may be at a premium or discount to the NAV.

A primary benefit of these funds is that interest rate risk declines as the fund nears its expiration date because shorter maturities have a shorter duration, which means less sensitivity to interest rates as the remaining time to expiration shortens.

3 types of distributions are subject to different tax rules, and the amounts of each distribution will be listed in the appropriate box in Form 1099 that each taxpayer will receive after the year-end.

  1. The liquidation distribution is a return of capital that is not taxable to the investor.
  2. The distribution is a tax-exempt interest dividend, which is not taxable.
  3. The distribution is regular interest, which is taxable.

Here are 3 of the major issuers of target maturity funds, along with some additional facts:

Of course, the Fund Analyzer also has numerous target date funds under the Morningstar Categories with dates ranging from 2000 to 2065+.