With interest rates moving up, investors can lock in money in fixed maturity plans for at least three years to earn higher, tax-efficient returns compared with bank deposits
As the rates of 10-year bond inch up, fixed maturity plans (FMPs) of mutual funds are attracting a lot of investors. Many asset management companies are lining up FMPs with tenure ranging from 1,080-1,405 days which can potentially earn returns of up to 8.5%. Post-tax (LTCG if you hold on for three years) and factoring in the indexation benefit, the real return can be around 7.5 to 7.8%, which will be higher than bank fixed deposits.
In fact, FMPs are closed-ended debt funds that invest in debt instruments for the period of maturity. 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.
Low risk of capital loss
For risk-averse investors, FMPs ensure low risk of capital loss as compared to equity funds because the funds are invested in debt instruments and the securities are held till maturity. Being a debt product, FMPs have negligible interest rate risk as the schemes invest broadly in assets maturing on or before the scheme maturity. Over time, debt as an asset class works well and builds up a strong portfolio. As per the norms of the markets regulator, a mutual fund cannot provide an assured returns scheme. So, FMPs only indicate the likely returns that the scheme will give to investors.
Before buying any FMP, look for the investment objective of the scheme, indicated yield and investment strategy. After you have understood all these factors, then you should invest and reap tax-efficient returns.
In most cases, FMPs invest in certificates of deposits, money market instruments, commercial papers and highly rated securities (like ‘AAA’ rated corporate bonds). Based on the tenure of the FMP, fund managers invest in debt instruments in such a way that all of them mature around the same time and there is no pressure at the time maturity. Returns from FMPs depend on the prevailing rates in the money market and investors get an indicative rate of return of the plan. These instruments are held till maturity, which saves on churning costs and results in a lower expense ratio for investors. Since FMPs are held till maturity, investors cannot exit before maturity. As a result liquidity is an issue.
For liquidity, look at bank FDs
If an investor is looking at liquidity, then he should prefer bank fixed deposits (FDs). In case of any emergency, bank FDs can be liquidated, with some penalty for premature withdrawal. But in FMPs one just cannot liquidate the money as the funds are close-ended and it can be withdrawn only after the scheme matures. FMPs can only be traded on the stock exchange where they are listed. As the secondary market is not yet developed in India, trading becomes very difficult.
They also offer better post-tax returns than bank FDs, especially for those in the highest (30%) tax bracket. These funds offer indexation benefits, which help to lower capital gains and thus lower the tax outgo. If an individual is in the 10-20% tax bracket, then bank fixed deposits or corporate fixed deposits with AAA rating could be considered. However, if an investor has no need to liquidate the investments and is in the 30% tax bracket, then a three-year FMP would make sense.
Analysts say investors should ideally use the current high interest rate environment to invest money in FMPs for at least three years till rates start coming down. FMPs are ideal for post retirement to earn higher risk-adjusted returns without any interest rate risks. Also, due to the restricted liquidity, investors who would not need the funds for the tenure of the scheme should invest in FMPs.