Why FMPs are a bright idea right now
As interest rates rise, FMPs become an attractive option, with better yields than fixed deposits, predictable results and more acceptable tax treatment. Closed-ended, so don’t wait.
Every time you notice a flood of fixed maturity plans (FMPs), you should pay attention to the reason for their launch. Usually, it means that there has been a spike in interest rates, which you, and in turn, the asset management companies (AMCs) that sell them to you, could benefit from. With the Reserve Bank of India tightening liquidity, we’re at this stage right now. Take your pick from up to 20 FMPs starting August 15 until August 27.
Short-term debt instruments are offering high rates, of 9.5% to 10.5%, which means that yields from them, which are predictable, unlike other mutual fund investments, would be at least 9.5%. Let’s find out why these funds are a better place for your money than your fixed deposit. And what its problems are.
What are they? FMPs are closed-ended schemes that invest only in debt schemes. Typically, funds offer schemes that mature in under three years. For one-year FMPs, the investments are usually in one-year commercial paper (CP) or certificate of deposits (CDs), but can also be in year-long non-convertible debentures (NCDs). Notice that investments mature when the FMP matures.
Are returns predictable? Returns depend on yields from the debt instruments invested in, of course. This is why FMPs are more popular when rates rise. This is when, as now, you would want to lock your money in. Until recently, AMCs even gave an indicated return on your investment until SEBI stopped this practice. This was done because there is uncertainty. Aside from the chance of default, there’s a chance of the yield changing by the time the AMC makes the investment. This can, however, be controlled to an extent by picking FMPs that will invest in only highly-rated instruments.
Calculating risk To minimise risk, you can check where the fund will invest. Funds will tell you where your money will be invested. To find these details, first see the list of schemes available on a website such as Value Research. Once this is done, search for them on Google to get the details. For example, DSPBR FMP Ser 111-12M Reg-G will invest 30-35% in A1+ CDs, 30-35% in A1+ CPs and the remainder in NCDs and bonds. Some schemes will also mention which sectors will be avoided. BNP Paribas Fixed Term Fund – Series 26 C, for example, will not invest in instruments issued by companies in the real estate, gems and jewellery sectors, micro finance institutions and airlines.
What are returns now? In August 2013, yields on CDs (the less-risky investment) and CPs (riskier) are on the high side. This is why the industry is abuzz with new fund offers. These investments are stable enough to offer returns similar to or higher than a simple bank fixed deposit, which are offering 9% to 9.5% right now.
Preferable tax treatment The more you must pay in tax, the more your interest will be in FMPs, particularly if you otherwise invest in FDs. This is because you must pay tax as you would on any other mutual fund, which is 10 per cent without indexation and 20 per cent with indexation for inflation (you can do this because FMPs usually mature in 367 days, making them eligible for indexation benefits). On FDs, on the other hand, you would pay as per your tax slab.
What are the problems? If you’re in the highest tax bracket, the FMP offers three amazing opportunities: to lock your money at high rates, earn stable returns and not pay too much tax on it. The one downside is that it doesn’t offer any liquidity. Even listed schemes aren’t known to give much liquidity. This means that you’re locked in for the entire duration of your investment (under three years). If you’re very concerned about the chance of a default (see ‘Are returns predictable?’ above), you should know that FDs are at least insured for up to Rs1 lakh.