FMPs are Best Investment option now As Interest Rates Rise

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Mutual Fund FMP

They offer tax advantage and higher returns than bank fixed deposits but little liquidity

The recent volatility in the debt market has seen a rush for launching fixed maturity plans (FMPs) by fund houses. On the one hand, given the recent spike in rates of interest in the economy, these schemes have become attractive to investors, and hence the rush. On the other hand, the turmoil in the bond market, with several of the regular bond schemes even showing negative returns, some of the jittery investors have been taking money off the table. To keep these investors within the same fund house, mutual funds have been launching FMPs in large numbers.

But why are FMPs the flavor of the season? An FMP is a closed-ended debt fund where the time to maturity of the debt instruments in its portfolio matches exactly with the maturity of the whole scheme. For example, if a fund launches an FMP for 367 days, meaning an investor investing in this fund will get his money back after 367 days, then all the debt instruments like certificates of deposit (CDs) and commercial papers (CPs) it has in its portfolio, will also mature after 367 days.

So there is no mismatch between the portfolio of an FMP and the time of maturity of the fund. Now since the CDs and CPs come with pre-defined rates of interest, so this aspect also gives the investor a very good idea about the kind of return he/she can expect by investing in the FMP. This
return is not guaranteed but fund houses only 'indicate' the magnitude of return they can offer in each FMP they launch. I market parlance, this is called indicative yield. Of late, some of the FMPs from better fund houses are offering indicative yields of 9.80% or even closer to 10%.

So what kind of investors should look at investing in FMPs? Those investors who want to have part of their investments in debt instruments, and have some money that they would not require at least for the next one year. However, any emergency corpus should be kept in a bank fixed deposit. This is because FMPs, although are compulsorily listed on the bourses, offer nearly no liquidity. If you don't need liquidity, FMPs are the best option in terms of returns. As an investor, you invest in FMPs for near-risk free return. So it's always better to stick to FMPs from good fund houses which do not take risks in these schemes. FMPs are also compared with bank and corporate fixed deposits. Here FMPs enjoy some advantages over FDs, and one of the top advantages is its tax efficiency. For example, a high net worth individual (HNI) invests Rs 1 crore in a 367-day FMP from a good fund house with an indicative yield of about 9.80%. In comparison, the FD from a good bank would probably give him about 9%. Now on the FD, the HNI would get a return of Rs 9 lakh while on the FMP he would get Rs 9.80 lakh. But on the FD he would be paying income tax at the highest rate of about 33%, so his net retur n would be about Rs 6 lakh. On the other hand, on the returns from FMP he would be paying tax at 10%, since this qualifies as a long term capital gain. So from the FMP, net income would be Rs 8.8 lakh. Thus at the comparative level the HNI will have about Rs 2.8 lakh more.

The post-tax returns from FMPs and corporate FDs (some of which are offering 12%), could be comparable, but at the current market and economic situation, investing in such FDs would mean taking huge risks.

Another advantage for FMPs is that they have lower expense ratios when compared with openended debt funds. This is because in FMP the fund manager invests once while in regular debt mutual fund schemes the fund manager often has to churn the portfolio, fund industry officials said. And this lower fund management costs are added to the returns that an investor can get in an FMP, they said.

FMPs also offer nearly nil interest rate risks at the time of redemptions. For example, if you invest in a short-term income fund which is usually open ended and want to redeem after a year. Here, in case the interest rate scenario is adverse, you may end up getting a lower rate of return at the time of redemption. On the other hand, if you are invested in an FMP, you can reasonably calculate the kind of return you would get at the time of redemption

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