A primer on FMPs

In a rising interest rate regime, fixed maturity plans can offer good returns. But exit in the interim is difficult because of listing.

When interest rates start going up, investors seek options that will give them good returns. There are various options – fixed deposits, debt funds, corporate deposits, non convertible debentures and fixed maturity plans (FMPs) of mutual funds.

FMPs are schemes with a pre-specified tenure. The basic objective is to generate steady returns over a fixed period. Thus, investors are assured of returns if they stay in these products for the entire period.

Since these products are of different maturities, investors have the option of buying schemes that suit their requirements. Since these schemes are closed-ended in nature, investors earlier had to pay an exit load. However, last year, the Securities and Exchange Board of India (Sebi) made it mandatory for FMPs to be listed in the stock exchanges.

At best, these schemes can be best equated with a fixed deposit in a bank, but with a caveat. The maturity amount of a fixed deposit in a bank is 'guaranteed', but only 'indicative' in case of an FMP.

Last year, Sebi issued a directive whereby fund houses were instructed not to declare any ‘indicative portfolio’ and ‘indicative returns’ to investors in FMPs. However, while buying it, one can look at the returns that are being offered at a particular time.

But what investment strategy do these FMPs follow? These are invested in fixed income instruments, like certificate of deposits (CD), commercial papers (CP), money market instruments, corporate bonds; debentures of reputed companies or in securities issued by Government of India and fixed deposits selected by the fund manager.

These have lower risk of capital loss due to their investment in debt and money market instruments and are least exposed to interest rate risk as the fund holds the instruments till maturity getting a fixed rate of return. Here, fund managers primarily invest in AAA, P1+ or such kind of good rated credit instruments with maturity profile of the securities in line with the maturity of the plan so there is also low credit risk with minimal liquidity risk involved.

Since the instrument is held till maturity, there is a cost saving in respect of buying and selling of instruments.

FMPs have better tax efficiencies whether you invest in the short term or in the long term. The long-term capital gains (investment of more than a year) enjoy indexation benefit (Indexation is a technique to adjust income payments by means of a price Index , in order to maintain the purchasing power of the public after inflation).

Importantly, if you stay invested for just over a year, there are double indexation benefits. For instance, if you buy an FMP of 14 months in February 2010, scheme will mature in April, 2011. In this case, the investor will get inflation indexation benefits for the years 2009-10 and 2011-12. After that, the tax rate is 10 per cent without indexation and 20 per cent with indexation.

In case of short-term capital tax, it is similar to interest income from bank fixed deposits. The returns are added to the income of the investor and taxed as per his/her slab.

However, remember that these schemes are not-so liquid anymore. Since they have to be listed at the stock exchanges, exiting before the scheme matures is difficult. For one, there are few buyers. And even if there are buyers, the units have to be sold at a discount. As a result, enter these products only if you are sure that

The writer works with ApnaPaisa.com