Fixed Maturity Plans (FMP) have been in existence for over a decade now. FMP have found favour with corporates as well as HNI (High Net worth Individuals) as it gave them a portfolio immunized to changes in interest rates. Retail investors have also started investing in FMP as an alternative to bank deposits. However with changes in capital gains tax on FMP’s, the attractiveness of FMP’s have down since 2014, when the tax changes were introduced.
Introduction to Fixed Maturity Plans (FMP)
FMP are closed ended schemes with a fixed period of time. The period could range from one month to as long as 5 year or even more. When the fixed period comes to an end, the scheme matures, and the money is paid back.
FMP invest in certificate of deposits (CDs), commercial papers (CPs), money market instruments, corporate bonds, government bonds and sometimes even in bank fixed deposits, with the condition that maturity of the instruments should be less than or equal to the tenure of the schemes. This feature of the scheme nullify the interest rate risk but the scheme still carries credit risk.
FMP are launched and kept open for a particular time period and investors can invest in that particular scheme only in that particular period. These schemes were generally marketed to corporates and high net-worth individuals. Nevertheless, the minimum investment is usually Rs 5,000 and a retail investor could comfortably invest too.
Once the initial public issue for the scheme is over investor can invest through the stock exchange, where the units of the scheme are listed.
Tax in FMPs
Long Term FMP investors for period of 36 months and higher enjoy the benefit of indexation. Tax with indexation on long term capital gain is 20% as per the union budget 2014-15.
FMPs of maturity of less than 36 months are taxed at base rate.
When to invest in FMP ?
FMP make good investments when investors want a certain return with low interest rate risk. For example, if a principal payment on a loan is due in a certain period of time or if there is an down payment to be made or if education fees have to be paid, FMP offers a steady return vehicle to cover the payments. FMP can offer higher returns than bank fixed deposits as yields on fixed income and money market securities are higher than interest rate on bank deposits.
On a longer term basis, FMP provide benefit of indexation on capital gains and when investors require a tax efficient, immunized portfolio, investments in 36 months or longer maturity FMPs can be considered.
Securities and Exchange Board of India has restricted mutual funds from declaring yields on closed-ended debt schemes. They were earlier also barred from disclosing the indicative portfolio of the scheme.
In year 2011, Securities and Exchange Board of India allowed close-ended debt schemes to disclose instruments in which they proposed to invest as well as floors and ceilings within 5 per cent range of the intended allocation. The aim was to help investors arrive at the return they could expect.
As per SEBI regulation on close ended mutual fund schemes it is mandatory that the listing of schemes on stock exchange should be done immediately after the launch of the scheme. This regulation provides investor an early exit route.
Illustration of Estimating the Returns on a FMP
We take a 3-month FMP floated by a mutual fund for our example. The indicative portfolio as given in the offer document is as follows.
The risk profile given in offer document is low, hence the fund would be investing in 91 days A1+ commercial papers.
The prevailing yields on the 91 days A1+ commercial paper at the time of the launch of the FMP was 9.95% p.a. The yields on securities are readily available on public domain like INR Bonds.com .
The fund manager invests 95% of assets in 91 days A1+ commercial paper and the rest 5% is kept as cash and cash equivalent that earns 8%. The annual return for the portfolio will be (95%* 9.95%) + (5%*8*) = 9.85%.
The fund house charges an expense ratio of 0.4% to cover its expenses.
Deducting the expense ratio from the portfolio returns, the annualized return for the scheme, if held till maturity, works out to 9.45%.
Risk in FMP
The major risk one sees in investing in FMP is liquidity risk. Once the investment is made in the scheme, the funds get locked in for the tenure of the scheme. The FMP are listed on stock exchange and the schemes trade on their NAV. However, unless there is good interest coming in from secondary market investors to invest in FMP that is quoted on the stock exchange, there will not be regular trading of the FMP on the exchanges.
FMP face credit risk as a default by an issuer on a security held by the FMP will lead to capital loss for the investor.
Opportunity cost risk is the risk of not investing in a higher yielding fixed income product. FMP lock in returns for an investor and if at that period of time, interest rates fall investor will not benefit from any mark to market gains.