Fixed maturity plans lose their shine after delay in full redemptions

Downgrades for Reliance Home Finance, Reliance Commercial Finance spook investors and distributors too.

Interest in fixed maturity plans (FMPs), from both distributors and investors alike, seems to have waned after a few companies delayed full redemption in certain schemes. 

About 24 schemes hit the market in April, according to Value Research. The period between January and March typically sees an uptick in the launch of FMPs; close to 139 plans hit the market this year.

“Distributors who have not understood the product completely and investors banking on fixed returns similar to those of fixed deposits, are the ones who have stopped showing interest in the product,” said Amol Joshi, a distributor. 

Fears of mark-to-market losses on debt investments, following multi-notch downgrades of debt papers of Reliance Home Finance (RHFL) and Reliance Commercial Finance (RCFL) has spooked investors further. 

According to Joydeep Sen, founder of wiseinvestor.in, the risk level is higher in close-ended funds such as FMPs than in open-ended funds, given that all the securities mature on the same day. However, there were still takers for the product among those who understood the scheme’s portfolio construction and its taxation. 

“Investors are putting money in FMPs that have a PSU or AAA-rated construct,” said Joshi. “If the objective of investment in an FMP is tax efficiency over a three-year holding period, the same tax efficiency is available in open-ended funds. Go for relatively lower maturity open-ended funds to limit market volatility,” added Sen. 

Investors are also gravitating towards schemes of fund houses that are perceived to be safer. Experts, however, believe that this may not be of much help given FMPs, much like other mutual fund products, are pass-through vehicles. Analysing the portfolio construct is, therefore, of greater relevance. High interest rates make FMPs attractive at this juncture. Three-year AAA-rated papers are yielding more than 8 per cent, while AA-rated papers are fetching 8.5-9.0 per cent.

While MFs earlier invested in papers below AA liberally, corporates are now reluctant to invest in FMPs that have below AAA-rated papers, preferring safety over returns. 

While FMPs can help investors circumvent the interest rate risk, they are susceptible to credit risk. This is especially pertinent in the current environment, when a number of corporates are facing the risk of defaults and downgrades.

“Investors need to find out how FMPs’ assets are distributed and ensure the investments are in high-quality names,” said a debt fund manager on the condition of anonymity.

Most MFs now sell FMPs with a maturity of above three years. This is because investors putting money in these plans before March 31 can claim indexation benefits for four years, instead of three.

Capital gains from investments in FMPs for below three years are added to one’s income and taxed in accordance with their individual slab rate of 10, 20 or 30 per cent as applicable. Investments for more than three years are treated as long-term capital gains and taxed at 20 per cent with indexation benefit. 

Indexation is the method of linking the price or value of an asset to an index of some type, for the purpose of adjusting for inflation.

On Friday, Care Ratings downgraded the long-term debt programme of Reliance Home Finance (RHFL) to ‘D’ (grade for instruments in default or expected to be in default), while downgrading other instruments to ‘C’. Earlier, these instruments were rated BBB-plus and in some cases, BBB.

Sebi’s new norms on uniformity of valuations require MFs to take “indicative haircuts” on exposures downgraded to ‘below investment grade’ from the date of the credit event. Such haircuts would be in force till valuation agencies compute the new price for such securities.