A few years ago, Fixed Maturity Plans (FMPs) were the rage. FMPs were designed to give investors a fairly certain rate of return in the backdrop of interest rate instability. These are closed-end debt funds, which means investments, can only be made during the new fund offer period. They also have a fixed maturity horizon which is declared at the outset. Depending on the maturity of the scheme, the fund manager selects debt instruments with identical maturity.
A big problem with FMPs was regarding the indicative yield that investors could look out for. This led to numerous risks in the portfolio. For instance, during 2006 and 2007, there would be a dozen FMPs clamouring for investors' attention and money during the same period. The only way one could stand up above the others was by offering higher indicative returns. And this was achieved by going in for lower quality paper that provided the higher return. In the race for returns, credit quality was the casualty. This was all the more relevant for the longer-term FMPs.
That was not all. Fund managers also began to take a gamble on the tenure of the paper. Ideally, the portfolio should sport paper that would mature at the same time as the scheme. This was not always possible and a number of them would opt for a slightly longer tenure since it would get them higher rates. Just before the scheme matured, the fund manager would sell the paper. The risk here was that if interest rates rose at the time of maturity, he would end up selling at a loss. And the final return would be lower than the indicative one.
Another problem that FMPs faced was if a dominant investor walked out. Many FMPs were corporate driven. But for a corporate, capex and other such factors are of more importance. If the money was needed before maturity, a corporate could very well pay the exit load and pull out the investment. If the fund manager had to sell some paper to meet the redemption, it would affect the investors who stayed on.
In 2009, SEBI resolved the above issues of undue risk by banning announcing of indicative returns and displaying indicative portfolios in FMPs. The regulator also made it compulsory for FMPs to be listed on stock exchanges. These measures were a direct fallout of the October crisis of 2008 which brought everyone to their knees.
Nevertheless, these schemes are not-so liquid anymore. Since they have to be listed at the stock exchanges, exiting before the scheme matures is difficult. For one, there are few buyers. And even if there are buyers, the units have to be sold at a discount. As a result, enter these products only if you are sure that you will stick with the FMP till maturity.
What investors should note
- Investors can opt for an FMP with a maturity period that is clearly in line with their requiremens.
- In an FMP, interest rate risk is not high and if the issuer invests in high quality paper, neither is the credit risk high
- FMPs tend to give better returns than bank fixed deposits, ultra short term and liquid schemes
- The long-term capital gains enjoy the indexation benefit. In the case of short-term capital tax, the returns are added to the income of the investor and taxed as per his/her slab.
- Investors can avail of double indexation benefits. For instance, if you buy an FMP of 14 months in February 2010, the scheme will mature in April 2011. In this case, the investor will get inflation indexation benefits for the years 2009-10 and 2011-12. After that, the tax rate is 10 per cent without indexation and 20 per cent with indexation.
