At a time when retail investors in not just stocks but also equity mutual funds feel devastated, debt seems to be a good option. And fixed maturity plans?designed to provide steady returns in volatile markets by investing the moneys in rated debt instruments of companies?are a safe avenue to park short-term surpluses. But over-enthusiastic execution of such schemes by some fund houses is killing investor faith in this decent product.

A rat race for shoring up assets under management (AUM) ensured that every fund house aggressively marketed the FMPs. With equity markets in doldrums since the beginning of 2008, the number of such plans more than doubled in the last 12 months to 975 with a total corpus of Rs 1,02,133 crore, according to Value Research. Today, FMPs account for almost a fifth of the total Rs 5.29 lakh crore AUM of the industry. Initially, these plans were sold to companies and high net worth individuals, but now even retail investors have started investing.

FMPs cannot promise any returns, but all of them publicise an indicative yield. Though it is not necessary for funds to generate the suggested yield, most of them try their best?and, perhaps make not-so-prudent investments. There have been instances in the past of funds being unable to generate the returns suggested in the offer documents.

Normally, the yields are better than the interest rate on fixed deposits. Combined with the superior tax benefits, FMPs have over the last year-and-a-half emerged as a lucrative option for corporate treasuries and high net worth individuals to park short-term monies.

So long as inflows into such schemes continued, there was no problem since receipts from a new plan helped them redeem earlier plans. With companies facing liquidity problems and HNIs turning wary, their interest in FMP products waned, making some fund houses jittery about their ability to meet redemptions. Left with no option, they are now seeking special treatment from RBI and Sebi. Some approached RBI to open up the repo window by adding more instruments so that they can borrow overnight moneys to meet redemption pressures.

While the RBI must desist from doing so, the capital market regulator Sebi must seize this opportunity to come clean on laxity shown earlier.

Five things the regulator must do now: One, review the commissions fund houses pay for attracting inflows. As of now, Sebi is worried only about commissions being paid from the particular FMP and loaded on to investors and this is capped at 1.5 per cent. It?s time Sebi clamps down on unreasonable commissions AMCs dole out just to get money flowing in.

Two, make a case for doing away with a preferential tax treatment for FMPs vis-?-vis fixed deposits (FDs). Interest income from FDs is taxed at the marginal rate of tax, but that from FMPs is taxed only at 20% with indexation. Such tax arbitrage distorts the market.

Three, make it mandatory for fund houses to continuously make disclosures on their asset quality. Some fund houses threw caution to the wind and invested in poor quality and unrated papers of companies. Investment in second grade paper of realty firms which are facing a terrible credit squeeze has already created problems for some AMCs. Sebi can ask funds to compulsorily get their FMPs rated by credit rating agencies. This will help investors take a more informed call.

Four, while it is not possible for 100 per cent matching of maturity of assets with the plan tenure, Sebi can prescribe a floor i.e. at least 95 per cent of the 180-day FMP?s corpus must be invested in assets with the same or similar maturity. Some funds floated 90-day plans but invested in 180-day paper, leading to serious asset-liability mismatches.

Last but not least, Sebi must ask the Association of Mutual Funds of India, a self-regulatory organisation, to seek disaggregated data on monthly AUM additions by fund houses. This will disincentivise the fund houses to indulge in unhealthy competition. Sebi may act now and prevent unwarranted bailouts.

pv.iyer@expressindia.com