Fixed Maturity Plans (FMPs) or Fixed Deposit (FD)?

Mutual Funds | admin | November 28, 2010 at 7:44 pm

Fixed Maturity Plan FMP Fixed maturity plans, or FMPs, are schemes floated by mutual funds and they work almost like a bank fixed deposit (FD). They come with different maturities like three months, six months, one and two years and rarely for three years.

FMPs invest in instruments of matching maturity and this gives investors a rough idea about the likely returns you can hope to pocket at the time of subscription. Since the portfolio is locked, investors are also shielded against interest-rate risks.

Also, FMPs with a maturity of over one year have a tax advantage over fixed deposits. Investors in FMPs have an option to pay tax on long-term capital gains at 10% without applying indexation or 20% after applying indexation to the cost of acquisition.

Interest from FDs is taxed according to the tax bracket applicable to the person. However, don’t go by the post-tax returns alone, as unlike bank FDs, FMPs do not offer assured return or capital protection.

If you plan to invest in FMPs, always look at the reputation of the fund house. This is very important because during the economic downturn two years ago, many fund houses got into trouble as they invested in low-rated papers from dubious companies, especially in the real estate sector. They just about managed to come out unscathed because of timely regulatory intervention and support.

However, the tricky thing about investing FMPs these days is you neither have an indicative portfolio nor return. So everything hinges on the integrity of the fund house.

Though an investor is supposed to stay invested till maturity in FMPs, fund houses also list FMP on stock exchanges so that investors can exit if they need money urgently. However, this does not guarantee enough liquidity and attractive price.

In short, consider investing in FMPs if you are comfortable with the concept and want to take a little risk to make superior tax-efficient returns.

As FMPs are passively managed funds, the portfolio turnover will be low resulting in lower transaction costs which enhances the returns for the investor. FMPs may have certain restrictions imposed in their portfolio construction based on offer terms. for instance, it might only invest in securities with an AAA credit rating or may not invest in debt issued by borrowers from a certain sector. Some FMPs include equity exposure in the form of convertible debentures.

FMPs, though they offer potential to earn better returns than Fixed Deposits are exposed to two types of risk:

1. Liquidity risk
2. Credit risk

Liquidity Risk
An FMP only invests in securities on a hold-to-maturity basis; once bought, each FMP or FD security is normally held until it matures. The secondary markets for debt securities is shallow at times. If for any foreseen reason a FMP is forced to sell a security during these times, it may leave limited options for such sale. The risk is called Liquidity Risk.

Credit Risk
The return offered by an FMP is entirely determined by the yields on the securities it has invested in. These yields reflects inter-alia in the credit risk of the borrowers – the riskier a borrower, the higher the yield of the borrowers offer their debt.
Investment in any debt contains an inherent risk of the borrower delaying or defaulting their obligations to pay the interest or redeem the debt on the due date. This risk is known as credit risk.

Summing up
Fixed Maturity plans are closed-ended debt schemes which are highly tax-efficient and normally offer favourable returns. However they offer no guaranteed return (unlike fixed deposits) and have limited liquidity options. FMPs can be an excellent investment for investors who clearly understand the risks associated with them.