What does your agent tell you when selling a fixed maturity plan (FMP)? That it gives better post-tax returns than bank fixed deposits (FDs)? Your agent is mostly right, but the problem is how to prove it.
Getting to know bank FD rates is easy; log on to their websites or just walk into any of their branches and you will find FD rates displayed since they are guaranteed. Ascertaining whether an FMP is good or bad is not that easy, unfortunately, thanks to a ban imposed by the capital market regulator, the Securities and Exchange Board of India (Sebi), in January 2009 on indicating returns. That is a problem for investors since an FMP locks your money (with unattractive exit options) for three months to a year, depending on your FMP’s tenor.
Also see | Growth Path (PDF)
But there’s a way out, provided you keep your eyes and ears open.
Read the newspapers
You may invest in mutual funds because, typically, you cannot decipher markets on your own and that’s why you need a fund manager to do it on your behalf. But when it comes to FMPs, the best way to predict returns is, curiously, from reading markets on your own. Here’s how.
An FMP is a closed-end fund that invests its corpus in scrips that mature just before the scheme matures. For instance, a one-year FMP will invest in debt scrips, namely commercial papers (CP) and certificates of deposit (CD) that will mature just before a year. CDs and CPs are instruments issued typically by banks and companies, respectively, to raise short-term money.
The income earned by the fund house is then passed to you. In other words, if you get an idea of what your fund house would earn, you get an idea of how much you would earn.
Newspapers are one of the best sources for information on these rates. So if you invest in a one-year FMP, watch out for interest rates of one-year CDs and CPs.
For instance, the Market Monitor section in Mint carries a lot of markets-related data, including the closing levels of the day before for global indices such as Hang Seng (Hong Kong), Kospi (Korea) and Nikkei (Japan). Look at a sub-section called “Key Indicators Money” and you will see debt market interest rates prevalent the day before, such as CD yield for a month and CD yield for three months. Similarly, other newspapers, too, publish interest rates of one-year CDs and CPs.
“Even if an ongoing FMP’s new fund offer (NFO) invests in these scrips after, say, a few days, once the NFO closes, it’s a good enough indication of what your FMP will earn,” says Ganti Murthy, head (fixed income), Peerless Funds Management Co. Ltd.
Note that an FMP will deduct its expenses, including fund management charges, from the total income it earns (about 0.50% in retail plans and up to 0.20% in institutional plans) and then pass the rest to you. Similarly, watch out three-month rates if you wish to invest in a three-month FMP.
Your distributor knows,probably
Try asking your agent. “Some of the big distributors also have their broking arms and are present in the debt markets daily. They have knowledge of the prevailing yields (of instruments in which your FMP would invest),” says Murthy. Many of these arms have sophisticated computers installed, such as those provided from Bloomberg and Reuters at their offices that provide data that help them in their research.
However, many fund houses discreetly claim that they quietly inform distributors about indicative yields. Distributors, in turn, would whisper in the customer’s ears. Says a research analyst with one of the top online distributors, who refused to be named: “When the fund house’s relationship manager makes a sales pitch about an upcoming FMP launch to agents, he typically tells them the quantum of returns that investors can expect. That way it becomes easier for fund houses to convince agents that these FMPs are worth investing in.”
The analyst added that many fund houses prepare copious Excel spreadsheets for potential investors giving—what is called—a simulation table of returns comparison of FMPs that provide indexation benefits vis-à-vis bank FDs. These are illustrative numbers, not assurances, to just give an idea.
“In the past year, FMP assets have risen so sharply that it cannot happen just on its own. Investors have obviously been indicated of the attractive potential returns that FMPs would be earning,” says the head of sales and marketing at one of the fund houses, who did not want to be named.
He said that his fund house avoids launching FMPs due to Sebi’s ban on indicating returns. “How do I tell my investor to lock in money with us for a year when I can’t even indicate what kind of returns s/he will get? Besides, FMPs are non-remunerative and fund houses earn a pittance. It’s not worth it,” he says.
Past performance can’t be relied on
Avoid looking at past performance when investing in an FMP. Debt funds are not like well-managed equity funds that perform well in the long run despite short-term blips. Also, FMPs lock your money at prevailing rates.
For instance, the one-year CD rate as on 1 June was 10.07%. Assuming your fund would have invested in it—and charged about 0.50% as expense ratio—you would have earned about 9.57%. On 20 July, the one-year CD rate dropped to 9.49%; the same fund would earn about 8.99% (9.49 less 0.50) had it been launched during this time.
“Retail investors will need to do some homework before investing in FMPs. But it’s not nuclear science; it’s manageable,” says Shobit Gupta, head (fixed income), Principal PNB Asset Management Co. Ltd. Further, once an FMP closes down or gets rolled over (an FMP that has matured returns the money to investors who seek redemption, seek fresh money and reinvests that and existing funds back into the debt markets), the past track record gets erased from public records.
With fund houses not allowed to indicate returns, your homework has gone up. But with information available easily, that shouldn’t matter much.
Graphic by Yogesh Kumar/Mint