Fixed Maturity Plans

Over the period of last few years, interest rates have risen due to uneven macroeconomic environment, rising international prices, and predominantly due to inflation, which forced the RBI to hike interest rates at least a dozen times since March 2010. The volatility in Equity markets have also been throwing an opportunity to look for alternatives. Fund managers have been locking these opportunities to offer Fixed Maturity Plans (FMPs) which give virtually assured returns. Since the indicative yield is now not allowed per new SEBI guidelines, one can assume returns in line with the similar tenure papers in the market minus expenses (which comes 30-50 bps for 1-year FMP).

What are FMPs? FMPs are closed ended debt funds with a fixed maturity period between three months to three years. The corpus of FMPs is primarily invested in corporate bonds, certificates of deposits, commercial papers and money market securities. FMPs are like other debt funds having dividend and growth options. The returns are in the form of dividends and capital appreciation.

Why invest in FMPs? For investors FMPs compare well with bank fixed deposits. While the returns in FMPs are not fixed, they do provide stable returns. In many cases the returns are higher than bank fixed deposits. Apart from several advantages, the tax benefits in case of FMPs stand out. Irrespective of the holding period, FMPs generate better post tax yield. Some of the FMPs are intelligently launched which spread over three financial years. For example in March 2012 many fund houses launch FMPs of the tenure of 390 days to 400 days. The popular fund houses which launched such products were HDFC, ICICI, UTI and DSP Black Rock. These FMPs will provide double indexation benefit as they fall in different financial years and thereby reduce or may even eliminate the long term capital gains. For an investor this is beneficial as long term capital gains are taxed at a lower rate and in case of long term capital loss they can be adjusted against other long term capital gains. It is generally noted that FMPs may provide returns up to 10.5% per annum. Bank fixed deposits on the other hand are also for a fixed tenure and for persons other than senior citizens may provide returns of up to 10% per annum.

Advantages of FMPs

• FMP products are suitable for those investors who want to park their money for a short period of time for some decent returns.
• They are suitable for the investors who want to keep their tax liability low.
• They are relatively safe and stable as compared to equity mutual funds.
• In a ‘dividend’ option the dividends earned are tax free at the hands of the investors.
• In a ‘growth’ option an investor can avail indexation benefit and reduce his long term capital gains tax.

Word of Caution

• For a longer horizon (i.e. 3 years to 5 years), the FMP is not recommended.
• FMP products are more risky than bank fixed deposits and therefore it is recommended the FMP products of only the reputed fund houses be purchased.
• FMP products with ‘growth’ option are recommended to those investors who are in the highest tax bracket so that they pay tax arising on long terms capital gains at a lower rate.
• Keep in mind that the Bank Fixed Deposit up to Rs. 1 lac come with deposit insurance while there is no insurance offered by the fund houses for FMPs.
• For a completely risk averse investor, conservative investment options are better than FMPs.

Despite the various pros and cons it has to be agreed that FMP products in the last two years have become increasingly popular form of investment. FMP products are indeed an innovative form of debt funds. This popularity continues presently more due to the poor performance of the equity markets. It remains to be seen as to how this popularity will change once the stock markets start performing better and whether equity funds will again take a better position in the investment market in the future.