Fixed maturity funds are not principal guaranteed
For investors with excess cash holdings and are looking for less risky investments, they may consider investing in time deposits and bonds since they offer interest payments on a regular basis and principal repayment upon maturity. There is a fund product known as fixed maturity fund with the prime objective to generate return by investing in a portfolio of bonds for a fixed period of time. These funds usually aim to make regular distribution payments. This makes it look like time deposits and bonds. However, neither distribution payments nor principal of the fund is guaranteed.
As its name suggests, a fixed maturity fund has a fixed investment term, typically of 2 to 3 years (or even longer at times). When the investment term comes to an end (reaches the fund’s maturity), the fund will be terminated automatically, and the liquidation proceeds will be returned to investors in proportion to their interests in the fund. To achieve this investment objective, the fund manager will usually invest in bonds that have a shorter or similar investment term as the fund, and will usually hold them until maturity.
We often associate time deposits and bonds with the word “guarantee”. Unless in default, interest payments and principal repayment of time deposits and bonds upon maturity are guaranteed. However, there is no such guarantee with fixed maturity funds.
- Fixed maturity funds do not guarantee principal repayment on maturity. The amount an investor receives after the termination of the fund depends on the liquidation proceeds largely generated from the disposal of the underlying portfolio bonds, which can be less than the principal.
- Fixed maturity funds usually advertise that they aim to make regular (e.g. monthly or quarterly) distribution payments. However, unless specified in the fund’s offering documents, the distribution payments, distribution amounts or distribution rates should not be regarded as guaranteed. Moreover, for those investors who are looking for regular distributions, they should be aware that distributions can be paid out of capital. Please refer to the article “Distribution policy for funds” for more details.
Given fixed maturity funds primarily invest in bonds, they too will be exposed to similar investment risks as those of bonds, which include default, credit rating and interest rate risks. Sometimes, these funds may even invest in high yield bonds which are below investment grade. The fund’s value and distribution payments will be affected by the performance of its bond portfolio. In addition, since a fixed maturity fund may invest in bonds with a shorter investment term than the fund, the principal received will either be reinvested in other short-term securities, or be placed as cash deposit as the fund’s maturity approaches. The reinvestment risk here is that the return of these reinvestments may be lower than the bonds previously held.
Fixed maturity funds possess certain features that are not typically seen in other funds. For instance, some fixed maturity funds may be closed to subscription after the initial offer period. Substantial redemptions during the term of the fund may render the fund size to shrink significantly and trigger the fund to be early terminated. Further, redemption from these funds prior to maturity may be subject to valuation adjustment or other investment charges, hence, adversely affecting the value and return of the funds to investors.
Liquidation on maturity is one the most unique features of fixed maturity funds. When we consider to invest in a fixed maturity fund, we should take into account our own investment horizon and cash flow needs, and avoid choosing a fixed maturity fund with an investment term that is shorter or longer than our own investment horizon.
19 August 2019