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Slow and Steady

Author: Team Finapolis/Friday, August 1, 2014/Categories: Mutual Funds

Slow and Steady

Fixed Maturity Plans or FMPs are back in favour now. Spurred by recent liquidity tightening measures by the RBI in a bid to curb the rupee’s freefall, short-tenor rates and yields on government securities have spiked sharply. This has turned FMPs that invest in short-term debt instruments and government securities an attractive investment option. 
 Asset management companies (AMCs) are lapping up this opportunity by launching several FMPs in the market in the last few weeks. In August alone, fund houses have launched nearly 35 FMP NFOs.  
So what has made FMPs an attractive investment option, at a time when finding good investment options is like looking for a needle in a haystack?

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Understanding FMPs
An FMP is a close-ended debt scheme and, as the name suggests, has a fixed maturity. FMPs primarily invest in short-tenor debt instruments such as certificate of deposits (CD), commercial papers (CP) and NCDs in such a way that the maturity of the papers is in line with the maturity of the scheme.
Since the papers are bought to mature in line with the scheme, the papers are not traded and held till maturity. The idea of holding the papers till maturity negates the interest rate risks. If, for example, a 12-month FMP invests in a 12-month CD quoting at 10.80% (as per yields as on August 16), irrespective of the fluctuation in the yields the fund will give a yield of 10.80%.
Generally, the funds will invest in different papers to generate higher returns. For example, a 12-month ‘AAA’ corporate bond quoting 11.50% is added to the above portfolio, with 50% weightage with the remaining 50% being in a CD. The expected yield goes up to 11.15%.
The CDs are available only for a maturity of up to 12 months. Thus, higher maturity FMPs would invest in corporate bonds. Here, the portfolio will be a mix of papers with highest yield and highest rating. However, the scheme may invest in slightly lower rated papers to increase the prospective yield.

Why Invest in FMPs Now
The recent actions taken by the RBI to control rupee depreciation have sent bond yields soaring. This presents an opportunity for investors to consider investing in FMP’s. This becomes all the more attractive considering equity markets are looking down the barrel and debt funds, which seemed to have attracted a lot of interest in the last few months owing to growing expectations about RBI lowering the rates, have also been volatile.
Considering the way the rupee’s freefall is continuing, it seems the stability in both the equity and debt space will take some time amidst intermittent positive cues. If the RBI decides to focus on growth rather than controlling the rupee and in effect inflation, positivity in the equity markets may creep in but, it looks like a difficult proposition at this point in time. However, assumptions aside, the best an investor can do is find instruments worth investing in to keep the returns closer to the inflation if not higher and FMPs can be a very good investment option.
FMPs at this point of time come as a respite. No wonder almost every mutual fund house is coming up with a series of FMPs with varied maturities. With so many funds available, it becomes even more important to choose schemes not only on the basis of the yields indicated (although one cannot give indicative yields as per SEBI guidelines, however the rates are given as a range based on the prevailing market rates) but the portfolio mix of papers as well.
In case of FMP with a maturity up to one year, check the portion allocated towards CDs, while in FMPs with maturities above 1 year check the allocation given towards AAA (highest rating for corporate bonds) papers and other lower rated papers. Do not fall into the trap of higher yields indicated by your advisor. For investor protection, the SEBI has given strict guidelines for not mentioning the indicative yields. However. a range can be indicated based on the papers being traded as on date.
Investors should consider his/her investment tenure as these schemes are closed-ended. Though these schemes are traded on the exchange, the volumes are very low and one may find it difficult to sell it on the exchange in case of emergency.
One more important consideration for an investor would be to choose the maturity based on the yields. A 1-year FMP may give 10.80% while a 2 year FMP may give 10.25%. One might feel investing in 1-year scheme is better although the investible surplus is available for 2 years as the yields on 2 year FMP is lower. An investor in such a case should consider the reinvestment risk, that is, the investment of the maturity proceeds received from the 1-year FMP. One year down the line, nobody can predict how the situation would be at that time. For example, at that time, the 1-year FMP might be quoting only 9%. The effective yield would be lesser than 10.25%, which one could have got from a 2-year FMP directly.

Tax Efficient
Many would compare FMPs with bank FDs considering the fixed duration. However, FMPs provide investors with a good alternative to fixed deposits given that they are more tax-efficient.
FMPs being a debt scheme, the long term capital gains (above 12 months) are taxed at 10% without indexation and 20% with indexation compared to fixed deposits where the interest amount is added to the investor’s income and taxed as 
per the tax slab. An investor in the highest tax slab might find LTCG at 10% 
very effective without indexation (See How FD and…).
Also, the high inflationary environment making way again, owing to the depreciating rupee, which might help FMP investors further if they utilise the indexation benefit. Under indexation, the investment capital is adjusted for inflation based on the CII (Cost Inflation Index) numbers released by the Ministry of Finance every financial year.

Choose the Right FMP
In this scenario when interest rates are going up, one fund which provides cushion is the FMP. 
If an investor has surplus amount to invest, knows the time horizon, wants to deploy the fund efficiently with least risk of capital and return, but wishes to optimize investment – FMP is the right scheme. Though the returns are not assured, he may expect the prevailing market rates with least risk.
It is however worth considering that you as an investor must consult the advisor and make sure the scheme being chosen is in line with your expectation not only in terms of maturity but also in terms of portfolio allocation. 

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