Come March and apart from equity-linked saving schemes, there’s another mutual fund (MF) scheme in the tax-friendly genre that offers an attractive proposition to make money—fixed maturity plans (FMPs). As of now, there are several of them on offer (to see full list of FMP new fund offers, or NFOs, go to www.livemint.com/fmps.htm). Most of these FMPs come with a tenor of one year, though a handful offer a tenor of three months too.
Also See | The FMP edge (PDF)
Also See | FMP NFOs (PDF)
Rising interest rates...
FMPs are closed-end debt schemes that come with a specific tenor, typically three months to a year, or even about two years. These schemes invest in debt securities that mature just before or on the date of the scheme’s maturity. In other words, a one-year FMP will invest in scrips that mature just before a year. Around the maturity date, it sells all its securities and pays back the money to its investors.
Typically, FMPs are most popular during March when short-term interest rates (rates of debt scrips of tenors up to a year) are on a high. However, short-term rates have been increasing consistently for the past nine months on account of tight liquidity in the banking system. Tight liquidity refers to a scenario when the demand for money is more than the supply for money.
Says Suresh Soni, chief executive officer, Deutsche Asset Management (India) Pvt. Ltd: “The bank’s credit-deposit ratio seems to be stretched and as a result there is a strain on liquidity. Hence, short-term rates have gone up.” Credit-deposit ratio tells us how much banks lend out of their deposits. For instance, if the credit-deposit ratio is 70%, it means that out of every Rs100 worth of bank deposits, it lends Rs70.
A high credit-deposit ratio indicates that banks lend from their own investments or their own capital. As a result, the Reserve Bank of India’s (RBI) credit policies have for long instigated banks to mobilize more and more deposits. Statistics from RBI, as on 25 February 2011, indicate that while deposits grew 16.4% year-on-year (y-o-y), credit grew 23.21% y-o-y. As a result, banks have been hiking deposit rates and also issuing certificates of deposit (CD; short-term scrips issued by banks to companies), consistently throughout the second half of 2010.
As per RBI data, as on 11 February 2011, the total outstanding amount of CDs issued by banks stood at Rs4.07 trillion, up from Rs3.44 trillion as on 8 October 2010 and Rs2.64 trillion as on 1 January 2010. “These CDs have increasingly been offering very good interest rates. Even bank deposit rates have been rising on account of the thrust to mobilize more deposits,” adds Vikrant Mehta, head-fixed income, AIG Global Asset Management Co. (India) Pvt. Ltd. Interest rates on CDs have gone up to about 9.9%, up from a high of about 7.05% in July 2010.
...make FMPs attractive
Since FMPs invest largely in CDs and commercial papers (CP; issued by companies), they benefit when the prevailing interest rates are high in the economy. Though the capital market regulator, the Securities and Exchange Board of India, in January 2009 banned FMPs to give indicative yields, most FMPs can easily offer 9.25-9.50% returns over a year at current market levels. Earlier, FMPs used to declare indicative yields at the time of launching. “We cannot give indicative yields, but suffice to say that on after-tax basis, FMPs outperform bank deposits for a person belonging to the highest tax bracket,” says a debt fund manager who did not want to be named. He adds that a lot of CDs that were issued last year and come up for redemption these days are also rolled over and reissued at the rates at which they were issued before because banks don’t have surplus cash to redeem them now.
How to choose
Choosing an FMP at the right time can be quite a pain. Most FMPs open and shut for redemption within a few days. Names of FMPs can also sound complicated with two issuances separated by just a week and saddled with serial numbers.
Ask your agent: The best way to keep track of FMPs is to be in touch with your agent. Ask for regular updates. Once you ascertain the time frame for investment, keep an eye on New Fund Offers (NFOs). Websites such as www.valueresearchonline.com offer a list of NFOs open at any point in time.
Limited points of sale: Unlike other FMPs whose application forms can be submitted at the registrar and transfer agent’s (RTA) offices, some fund houses insist that applications be submitted directly at the fund’s office. “Typically, we launch FMPs in quick succession and they are open for a short period of time. If investors come to us directly, we can keep a close eye on the number and value of applications. It’s important for fund managers to keep a close watch,” says the head of sales department at an international fund house, who did not want to be named since he is not the official spokesperson.
Which plan to choose? FMPs are taxed like any other bond fund. If held for at least a year, you pay tax at the rate of 10.30% (including surcharge) without indexation or 20.60% with indexation. Compared with that, interest on bank fixed deposits are taxed at your income tax rates (30.90% if you are in the highest tax bracket). For tenors of a year or more, go for “growth” option. For tenors less than a year, opt for dividend plan.
There’s a trick in the book that helps you save taxes on your FMP investments. Despite long-term capital gains tax on debt funds at 10% without indexation and 20% with indexation (depending on the option you choose), you can save taxes by choosing the indexation option, especially in FMPs launched towards the end of March and those that come with a tenor of little over a year, so that it covers two accounting years.
For instance, a 400-day FMP that closes on, say, 21 March 2011 would mature on 23 April 2012 and would cover two accounting years; 31 March 2011 and 31 March 2012.
On account of rising inflation—and the subsequent decrease in the value of money— the government allows the cost price of a financial instrument (in this case, your FMP) to be inflated, so that the profit (difference in selling price and cost price) gets narrowed down. For instance, the cost price of Rs1 lakh invested in an FMP today will become about Rs1.12 lakh at the time of maturity, assuming the cost inflation index goes up by 6% after 31 March 2011 and a further 6% after 31 March 2012.
Since the repurchase price of the FMP is Rs1.09 lakh (less than Rs1.12 lakh; the inflated cost price), your investment shows a loss on paper and hence you don’t pay tax. Typically, FMPs launched during the last fortnight of March offer double indexation (covers two accounting years).
This time though, there’s a twist. With the proposed direct taxes code (DTC) slated to come into effect on 1 April 2012, your double indexation FMP will mature in the DTC regime. Some fund managers are cautious and feel that DTC may not offer double indexation. “We have sought opinion from several tax experts and get different views. It’s unclear,” says Soni, who launched a double indexation FMP in January 2011 based on what tax experts—whom the fund house had consulted in those days—had suggested.
Now, he adds, he keeps getting conflicting views. “Double indexation may or may not be around once DTC comes. That is a call that investors will need to take how important is double indexation,” says Chaitanya Pande, head (fixed income), ICICI Prudential Asset Management Co. Ltd.
Some are more optimistic though. Gautam Nayak, a chartered accountant, says that double indexation benefits will be around. “There is nothing in the DTC that says that it won’t be there.”
Despite DTC uncertainties, invest.
Illustration by Jayachandran; graphic by Yogesh Kumar/Mint