Star Wars is probably one of the most popular television shows ever created. This science fiction show has been particularly famous amongst kids. I have myself seen quite a few episodes of it, which is my kids? idea of spending quality time with their dad. Anyway, the reason I am talking about Star Wars is because the current economic scenario reminds me of the famous Star Wars slogan ?Expect the Unexpected?, with a slight change. For the markets, the slogan would be ?Accept the Unexpected?.
The Indian stock markets have thrown in so many surprises that we have started to accept its unexpected behaviour. The 2007 crash wasn?t expected and neither was the recent surge. The October 2008 debt fund liquidity crisis wasn?t expected and a revival in the fortunes of Fixed Maturity Plans (FMP) certainly wasn?t.
As is common knowledge now, the debt fund market faced a major liquidity crisis in October 2008, after which, Sebi decided to make a few changes in the way these funds were run. FMPs, one of the most popular and useful type of debt funds, were expected to bear a major brunt of these changed rules to such an extent that it appeared that FMPs would get totally killed off. But that hasn?t happened, in fact, the opposite has. FMPs have seen a resurgence, with almost Rs 6,000 crore worth of fresh investments!
FMPs are mostly used by companies and large investors as they provide a good option to bank fixed deposits. FMPs are close-ended funds that invest in debt instruments with the intent of holding them to maturity. This means that one can invest in them only during the NFO and exit only after the stipulated period of holding. However, investors could actually exit from FMPs after paying a heavy load, which is what happened when the liquidity crisis hit. Investors exited heavily and the funds were left holding bonds that were unsellable. Hence, they resorted to large amounts of bank credits to honour the redemptions. Sebi?s new decreed solves this problem by making FMPs truly close-ended. FMPs are now listed on stock exchanges, which is the only means of premature exit.
The other so-called problem with FMPs was that fund companies offered an ?indicative return? while selling these funds. In essence, the returns that an FMP would generate are fairly predictable because such funds invest in debt instruments that are largely unaffected by market gyrations. However, Sebi has now barred fund companies from offering such indicative returns.
Both of these changes in the functioning of FMPs are apt and were very much required. But in December, when these changes were put into effect, it did seem like they would shut the door on FMPs. It was widely accepted that without indicative returns and an easy exit option, FMPs would be unattractive investments.
Well, that was expected, but it hasn?t happened. FMPs are still very much attractive. The basic reason behind this could be the fact that even with the new changes, FMPs are better options than FDs, certainly more tax efficient. When you put money in a fixed deposit, the interest gets added to your income. In FMPs longer than a year, if you elect to take all your gains as capital appreciation, the taxation is merely 10% with indexation benefit or 20% with indexation.
Given the tax efficiency and reasonably predictable returns, seems quite obvious that FMPs would still attract investors. Wonder why we thought otherwise?
The author is CEO, Value Research