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Business News/ Opinion / Most fixed maturity plans outgun fixed deposits
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Most fixed maturity plans outgun fixed deposits

An analysis by Crisil shows that as a category, FMPs have given better returns than FDs of 1-3 years

Shyamal Banerjee/MintPremium
Shyamal Banerjee/Mint

When it comes to fixed-income investment for the short to medium terms, there’s nothing quite like fixed deposits (FDs), right? Wrong.

An analysis by Crisil shows that as a category, fixed maturity plans (FMPs) of mutual funds (MFs) have given better returns than FDs of 1-3 years—the typical investment period in FDs.

The study indicates more than 92% of the FMPs launched since 1 April 2007 have beaten FD returns over comparable time frames since then, even on a pre-tax basis. Post-tax, the gap only widens further, given the FMPs’ innate tax efficiency.

FMPs are closed-end MF schemes with a pre-defined maturity, whose primary objective is to generate steady returns over a fixed tenor, typically one month to five years. They shield investors from interest rate fluctuations by investing in a portfolio of debt securities (predominantly certificates of deposit, commercial papers and non-convertible debentures) whose tenor matches that of the scheme. These securities are redeemed at the end of the FMP term. For example, if the FMP is for 12 months, the fund manager invests in instruments with maturity close to 12 months.

FMPs maturing in 12-15 months are the most popular as they give investors single or double indexation benefit, thereby shoring up the returns.

Crisil compared the returns delivered by FMPs from inception to maturity with 1-year and 3-year FD rates prevailing at the inception of the FMPs. A total of 1,563 FMPs, with tenor of 12 months or more, launched and matured between 1 April 2007 and 30 November 2013 were taken. The performance of 12-15 month FMPs was compared with that of 1-year FDs, while FMPs with 15-36 month maturity were compared with 3-year FDs.

Almost 93% of these FMPs had outperformed FDs on pre-tax basis. The 12-15 month FMPs delivered an average annualized return of 9.40% (versus 8.33% of 1-year FDs). On the other hand, 75% of FMPs with maturity of 30-36 months bettered 3-year FDs—8.65% versus 8.07%.

Even after taxes, FMP returns fare better, thanks largely to the indexation benefit. Interest received from FDs is subject to tax at the investor’s marginal rate of tax, which can range from 10% to 30%. But long-term FMPs (more than 365 days) are taxed at 20% with indexation or 10% without indexation, whichever is lower.

Under indexation, the purchase price of the investment is increased to include the inflation rate over the holding period. The inflation is calculated using a government notified factor called cost inflation index. Indexation reduces the effective taxable capital gains component, lowering the tax outgo. Investors have a choice of either using or not using this indexation benefit. The option that gives a lower tax outgo can be selected.

The analysis shows that on a pre-tax basis, FMPs have delivered at least 50 basis points (bps, or one-hundredth of a percentage point) more than FDs. After availing indexation benefit, post-tax returns of FMPs are higher than FDs by more than 140 bps.

FMPs with maturity of a little over 12 months also offer double indexation benefit, which comes into play when the scheme purchase is made in one financial year and the maturity of the scheme is after two financial years. For example, if an investor invests in a 13-month FMP launched in March 2011 (financial year 2010-11), it will mature in April 2012 (financial year 2012-13). As the investment period is spread over three financial years, the investor can adjust the investment amount with inflation of two financial years. This exercise allows her to reduce the tax liability considerably.

MFs keep track of the prevailing interest rate scenario and launch these schemes when interest rates are at relatively high levels. The trend analysis of FMPs launched since 1 April 2007 shows that a greater number of FMPs were launched in the high interest rate period—64.45% of the 2,225 FMPs with maturity greater than one year were launched when 10-year government securities yield was higher than 8%. The trend clearly shows that FMPs allow investors to lock in their investments at higher yields.

Over the past two years, when yields have been on the higher side, there have been several FMPs launched with maturity close to 60 months, thereby allowing investors to lock in higher yields for longer time frames.

Mukesh Agarwal is president, Crisil Research.

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Published: 09 Jan 2014, 06:42 PM IST
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