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Post-tax returns seen more in FMPs due to double indexation

 

Investors looking to beat fixed deposits offered by banks are eager to park their money in Fixed Maturity Plans, or FMPs, to cash in on the spike in interest rates due to spiralling inflation and tight liquidity conditions. FMPs are close-ended debt schemes. These are passively managed funds with a low portfolio turnover resulting in lower transaction costs and enhanced returns. The industry AUM (asset under management) as on December 31, 2010, stood at Rs 6,51,708 crore, of which FMPs generated Rs 68,418 crore."Even though the yields have been heading higher, the upside seems limited from the current levels. Also, February and March are ideal months to lock in money in these products as investors also claim tax advantage. While a fixed deposit attracts tax as per an investor's tax slab (over 30% for last slab), a 13-month FMP only attracts a tax of about 20.6% (after adjusting for inflation, which is called indexation). In the case of FMPs, double indexation enhances post-tax returns. For instance, if one invests in a 370-day FMP on March 29, 2011, it will mature on April 2, 2012. However, for income tax purposes, the investment is done in FY 2010-11 and sold in FY 2012-13. Thus, investors reap the benefits of indexation for two years — 2011-12 and 2012-13 — and the tax outgo reduces accordingly. Compared to 1-year fixed deposits offering 9-9.5%, which post tax comes to around 6.5%, if an investor parks his money in a 15-month FMP with 100% bank CD portfolio, yields are expected to be better by at least 50 bps. While fund managers are not allowed to give indicative returns on fixed-term portfolios, the general consensus is that the posttax yield will be easily around 8.5-9%. FMPs are available in dividend and growth options, but for investments with less than 1-year tenure, it is advisable that an investor opts for the dividend option since income can be distributed as dividend on which 13.841% tax will be paid. The only counter-argument for not investing now could be to wait for a month or so for advance tax outflows of March and expect yield levels to move up further.


On the flip side, liquidity could be a problem and investors seeking premature redemption may have to sell at a discount to the net asset value or even bear losses on their principal amount.

 

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