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FMPs best bet in high interest rate scenario

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INTEREST rates are high, equity markets are volatile: So where do you invest? Fixed maturity plans (FMPs) could be one of the answers. The past one year has seen a large number of FMP launches across various maturities, ranging from 90 days to three years.

FMPs have seen interest from both retail and institutional class of investors.

Definitely, rising interest rates could be one of the key reasons for the popularity of FMPs among investors.

Over the past two years, CD (certificate of deposit) rates have risen by 400-500 basis points (bps) or more. Similarly, corporate bond yields have also risen by 100-200 bps or more. Short-term CDs, CPs (commercial paper issued by companies) and corporate bonds are the preferred debt investments of fund managers of FMPs.

One needs to only take a look at the portfolios of FMPs of various fund houses that are published on their websites.

What has been the reason for the rise in interest rates? High inflation, rates hikes by the Reserve Bank of India (RBI), tight banking system liquidity and government's high borrowing in this and last financial year. RBI has hiked rates by 13 times since October 2009. In the most recent RBI policy review announced on October 25, RBI has indicated that they may be nearing the end of the rate tightening cycle.

Thus, we may see short term rates peaking off in the near future. Accordingly, it could be an opportune time to lock investments in this high interest rate scenario by investing in FMPs.

The question then why not traditional investment options, which are also offering high interest rates, or other debt schemes like gilt and income funds. As far as those traditional options are concerned, the main benefit for a tax-paying investor, especially, if she/he falls in the higher tax bracket, is the lower tax rate on FMPs, which makes post tax returns far higher for comparable tenure FMPs. FMP returns are market-linked and you may take advantage of higher rates, however, traditional products rates move with a lag, so, even if market rates move up, it does not necessarily mean those products rates would also move up. However, traditional investment products do give certainty of returns as the rate of return is known. In case of FMPs, the actual returns are not known, however, in consultation with one's financial adviser, who may be aware of the market movements, one can get a good idea of the range of returns that can be expected as fund managers invest in debt instruments maturing in line with the maturity of the FMP. FMPs, thus, carry very low interest rate risk (risk of adverse mark-to-market movement), and this is one of the advantages that they have over duration funds like gilt funds and income funds, which can be more risky.

FMPs do carry credit risk, even though, they take exposure to companies, banks and other institutions. However, with new regulations introduced by the Securities and Exchange Board of India (Sebi), mutual funds are required to declare the indicative portfolio with indicative ranges not exceeding 5 per cent in the SID (scheme information document) of the asset classes (CPs, CDs, gilts) and rating classes (AAA, AA) that they plan to invest in at the time of launch itself. This may help an investor to understand the credit risk in an FMP portfolio that he is looking to invest in. Further, mutual funds are also required to disclose credit evaluation policy for the investments in debt securities in the SID of the FMP.

All in all, the ease, convenience and transparency of investments make FMPs one of the suitable investment products to take advantage of in the present interest rate scenario.

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