Fixed maturity plans or FMPs have been preferred by a section of investors who view it as a tax-efficient alternative
FMPS reduce the cost of money management due to extremely low portfolio churn
MUMBAI: FMPs are essentially close-ended funds where new fund offer (NFOs) are launched for a pre-determined period and then closed for subscription. The maturities of these FMPs are pre-determined too and could differ across tenures from as low as one month to as high as 10 years. The most popular tenure continues to be the three-year FMPs. Here are the benefits of FMPs:
Return predictability: FMPs are essentially an alternative created by mutual funds to counter popularity of FDs. FDs offer a fixed rate of return, while FMPs indicate the potential returns that can be generated by the scheme. Fund manager’s ability to buy and hold the portfolio securities until maturity and matching the tenure of portfolio securities with the tenure of the FMPs makes this exercise easier.
Reduced volatility: While openended funds are susceptible to change in NAVs based on interest rate movements, the same impact on NAVs of FMPs is largely disregarded as by the time the FMP matures, largely the coupons of the bonds have been received and the bond value tends to par value. Thus, the portfolio shocks are immunised by the end of the FMP tenure.
Market driven yields: Debt market consists of large institutions across banks, corporate treasuries, NBFCs, financial institutions and public sector undertakings, which borrow across maturities with the aid of various instruments. A three-year AAA corporate bond will always be issued at a premium which will be fairly higher than the rate of overnight borrowing. For instance, today’s overnight rate is 6% and for a three-year AAA corporate bond is 8.15%, which means a spread of 215 basis points. Thus, if the FMP invests in a portfolio of such bonds, it can generate gross returns of 8.15%.
Lower costs and tax efficiency:
FMPs reduce the cost of money management due to extremely low portfolio churn. Thus, they are also managed at relatively lower expense ratios which benefits the end investor. When invested with a three-year horizon, the indexation benefits for mutual funds kicks in and thus, FMPs become a great way to provide tax efficient returns.
Risks in FMPs: Let us continue with the above example. The portfolio manager can also invest in securities which are below AAA, could be AA or AA- and build a portfolio with higher yield of 12%. This may look lucrative but we have to be aware of probable outcomes. A fixed income investor always needs to question the driver of returns which can come by adding credit risk to the portfolio. It is okay to have this exposure if the funds have a mandate to invest in lower rated credits and the same is mentioned in the offer document.
The responsibility then lies on the investor and the distributor to be coherent with the scheme objective before investing. The risk of a default or delay in payments is a real one. The money parked in FMPs also gets locked for the specified tenure, thus providing no liquidity.
The units are listed on the exchange but it is hugely illiquid for all practical purposes.
Invest if you understand the risks and benefits associated with FMPs; if you have a trusted advisor/distributor who considers them suitable for you; invest in a high quality FMP if you are riskaverse.