Central bank move spurs MFs to launch fixed maturity plans

Written by Ashley Coutinho | Mumbai | Updated: Jan 25 2012, 08:57am hrs
Mutual fund houses are rushing to launch fixed maturity plans (FMPs) in anticipation of a decline in interest rates in the coming months. The RBI indicated the reversal of its monetary stance by slashing the cash reserve ratio (CRR) by 50 basis points on Tuesday.

About 18 different FMP schemes are currently open for subscription, of which nine schemes have tenure of one year and six have maturities exceeding a year. Whats more, in the past month, about nine fund houses have filed with the market regulator Sebi to launch FMPs.

FMPs are cyclical products that see an uptick when interest rates are high. Investors expect interest rates to come down in the coming months, so this is a good time to lock in investments at these high rates, said Lakshmi Iyer, head fixed income & products, Kotak Mutual Fund. Added Sujoy Das, head fixed income, Religare Asset Management: FMPs are typically targeted at investors who are risk averse on interest rates.

Currently, most one-year FMPs offer returns of 9.7%-9.8%, two year plans offer about 9.4% and three-year plans offer 9.25%. Market participants believe that the CRR cut of 50 bps will only have a marginal impact on the returns offered by FMPs as liquidity continues to remain tight. There will not be much of an impact. The returns offered may decline by about 10-15 basis points in the near term, said Murthy Nagarajan, head fixed income, Tata Mutual Fund.

FMPs are close-ended mutual fund debt schemes with a fixed maturity date and invest in corporate debt, government securities and money market instruments. As the securities are held to maturity, the final returns are not impacted even if the underlying investments in these plans fluctuate.

There are tax benefits. FMPs are treated as a debt fund and incur long term capital gains for schemes maturing after a year, said Anil Rego, CEO, Right Horizons. The investor can choose between a 10% flat tax on returns or 20% tax after indexation for inflation. If the investor opts for a dividend option, then he has to pay a dividend distribution tax of 14.16%.

For maturity period of less than a year, the gains are added to the investors income. Schemes with tenure of more than one year aim to benefit from double indexation, wherein the inflation cost for two years is added to the purchase price of the units.

FMPs are meant to be held till maturity but investors can exit if they want to by selling their units on the stock exchanges, where FMPs are listed. However, investments in FMP come with credit risks. As with investment in any corporate security, there is an element of credit risk involved if the company delays payment or does not pay up at all, said Das.