With a spike in bond yields, investors are looking to reduce credit and interest rate risks. And to attract risk-averse investors, mutual fund companies are launching a host of fixed-maturity plans (FMPs).
In these volatile times, risk-averse investors are preferring closed-ended debt funds because of the higher interest rate and double-indexation benefit that FMPs offer. For fund houses, the investment objective of FMPs is to generate returns and protect the capital invested as the schemes invest in debt products with a fixed maturity. In fact, FMPs score better than bank deposits because of their tax efficiency. Also, FMPs have lower expense ratios compared with open-ended debt funds because the fund managers do not have to churn the portfolio, which, otherwise, adds to the costs for the investor.
In August, mutual fund houses launched a host of FMPs across tenures ranging from one month to over a year. UTI Mutual Fund announced a new fund offer (NFO) for UTI Fixed Term Income Fund- Series XVI- III for 368 days. The scheme is available for subscription from August 22 to August 28. Similarly, HDFC Mutual Fund announced the NFO of HDFC FMP Series for 370 days. The scheme will open and close for subscription on August 28. DSP BlackRock MF has launched two FMPs with maturity of three and 12 months.
Analysts say it is a good time to invest in FMPs as these are close-ended funds with a lock-in strategy and invest mostly in specified-duration instruments, such as company deposits and commercial papers where interest rate risks are much lower.
Dhawal Dalal, executive vice-president and head of fixed income, DSP BlackRock Investment Managers, says investors should take advantage of the recent spike in money market yields and consider investing in one-year FMPs and prefer quality and liquidity over credit and yield.
Following the liquidity-tightening measures taken by the RBI to strengthen the rupee, assets under under management of MFs in the debt fund category (liquid funds) fell by R45,296 crore, or 21%, to R1.29 lakh crore in July because of large-scale redemption. Bond yields and return on debt funds move in opposite directions; that is, as bond yield rises, return falls and vice-versa.
Fixed maturity plans, being debt products, have negligible interest rate risk as the schemes invest broadly in assets maturing on or before the scheme maturity.
Moreover, fixed-income investments offer opportunities in both rising as well as declining interest rate regimes. Over time, debt as an asset class works well and builds up a strong portfolio. Despite the current volatility in debt, analysts say, the allocation towards it should not change much and the portfolio must be maintained as per the near-, medium- and lomg-term needs of an investor.
As per regulatory norms, MFs cannot provide assured returns. So, FMPs only indicate the likely returns that a scheme will give. Investors also have an option to pay tax on long-term capital gains at 10% without applying indexation, or 20% after applying indexation. One should consider investing in FMPs only if he is willing to take some risk for tax-efficient returns. Also, for risk-averse investors, investing in FMP makes more sense as post-tax, the returns are higher than bank deposits.
However, under Deposit Insurance and Credit Guarantee Corporation (DICGC), each depositor in a bank fixed deposit is insured up to a maximum of R1 lakh for both the principal and the interest amount held by him as on the date of liquidation/cancellation of bank's licence or the date on which the scheme of amalgamation/merger/reconstruction comes into force. All commercial banks, including branches of foreign banks functioning in India, local area banks and regional rural banks, are insured by the DICGC. Also, all state, central and primary cooperative banks, also called urban cooperative banks, are covered. Investors must note that for FMPs, there is no such guarantee on the capital in case the fund house suffers a loss on the investment.
Typically, AMCs launch FMPs in March with a 12-month lock-in period because of the benefits of double indexation for those who stay invested in these products for over a year. For example, a 13-month FMP launched in February 2013 will mature in March 2014 and as it will pass through two financial years, it will have benefit of double indexation.