Home / Money / Personal Finance /  The better way out of a troubled fixed maturity plan for investors

In the past few days, two fixed maturity plans (FMPs), from Kotak Mahindra Asset Management Co. Ltd and HDFC Asset Management Co. Ltd, have faced trouble due to their exposure to Essel Group’s debt papers. In one case, investors got most of the payment, but the AMC held back some units until the recovery of money from Essel Group. In the other, the AMC rolled over the FMP for clients who agreed to it. In the coming months, the trouble may spread to FMPs of other fund houses having exposure to Essel Group. Shaikh Zoaib Saleem asked experts which of the two ways is better for investors:

It’s better to book losses and invest elsewhere

Pattabiraman Murari, FreeFincal
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Pattabiraman Murari, FreeFincal

Pattabiraman Murari, Founder, FreeFincal

The way AMCs and rating agencies have dealt with the crisis is far from inspiring trust. Should investors exit or opt for roll over if the AMC gives that option? Even if one opts for a rollover and the fund house is able to recover the money, the delay will reduce the yield as the net asset value (NAV) will take weeks or months to recover to its pre-crisis value. I think it would be better for investors to take the loss, get rid of the uncertainty associated with debt recovery and invest elsewhere.

What else can be done to safeguard investors? Risk in a debt mutual fund is inevitable, but it can be compartmentalized. One can have debt funds that invest only in short-term gilts, only in long-term gilts, only in corporate bonds or only PSUs and so on. Such style of purity, especially in FMPs, offers choice. Those seeking higher yields can choose corporate- or PSU-based FMPs. Those who cannot stomach any credit risk can stick to gilt FMPs.

Investors must recognize that FMPs can’t replace FDs

Sandeep Parekh, Finsec Law Advisors
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Sandeep Parekh, Finsec Law Advisors

Sandeep Parekh, Partner, Finsec Law Advisors

The mutual fund imbroglio is not as bad as it sounds. Had investments completely soured, the specific scheme would have written off the amount and returned the balance to investors. The deferral is the lesser of two evils. What was likely to be a default situation has been deferred with a higher security cover. There is higher probability of investors getting their money back , but there is no guarantee.

Whether to hold back units, or roll over the payback period, or just take a haircut is a call fund managers and investors must take. None of the options is inherently superior to the other as immediate liquidity must be faced with an immediate haircut, while a deferment is likely to return more money but only in the future. Ultimately, investors must recognise the risky nature of these products, and fund managers must turn more cautious as FMPs are often sold as replacement for fixed deposits (FDs). They aren’t.

Getting back some of the money is the better option

Suresh Sadagopan, Ladder7 Financial Advisories
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Suresh Sadagopan, Ladder7 Financial Advisories

Suresh Sadagopan, Founder, Ladder7 Financial Advisories

The way the two fund houses have handled the problem is slightly different. But, fundamentally, in both the cases, the risk is still very much with the investor. That being said, I would prefer the Kotak AMC way of handling this situation because that would mean that I would have got almost 100% of my money back. If I invested 100 and it has gone up to 127 over a period of time, some money, maybe 20, is stuck, but I still got 107.

The fund houses are expected to do the due diligence, but as a debt fund investor, the risk also belongs to me.

One of the things that’s been said, which I agree with, is that AMCs should not get into the lending business. There is a thin line between direct lending to a business and buying securities. Direct lending involves more due diligence. AMCs are not business consultants and should not get into the business of being part-owners, which has happened in some cases.

FMP investors should get to decide if they want to stay

Vishal Dhawan, Plan Ahead Wealth Advisors
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Vishal Dhawan, Plan Ahead Wealth Advisors

Vishal Dhawan, Founder, Plan Ahead Wealth Advisors

FMPs are market-linked instruments and are, therefore, exposed to the return and risk characteristics of the underlying bonds in the portfolio.

As they have a maturity date, they are perceived to be similar to bank FDs; also, they offer the benefit of tax arbitrage to investors in higher tax brackets. Thus, a lot of investors tend to use them for specific goals. Any fixed maturity instrument that does not permit liquidity at the point that it was promised could, therefore, create challenges for investors. So it is critical that, irrespective of the underlying performance, investors are able to choose whether they wish to stay or not. Investors who do not need liquidity could decide on the basis of the risk in the underlying security.

Ideally, investors should use open-ended debt funds so that they have more flexibility to make these changes, as underlying security performance, tax laws and needs of liquidity can change over a period.

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