Fixed Maturity Plans

Fixed Maturity Plans (FMP)

What are FMPs?

FMPs as they are popularly known are investment schemes floated by mutual funds and are close-ended with a maturity period ranging from one month to five years. These plans are predominantly debt-oriented, while some may have a small equity component.

What is the objective of FMPs?

The basic objective of pure debt-oriented FMPs is to generate steady returns over a fixed-maturity period, thus protecting the investor from market fluctuations. FMPs are structured to offer capital protection and appreciation without an explicit guarantee.

How do FMPs work?

FMPs are passively managed fixed-income schemes, where the fund manager locks in to investments with maturities corresponding with the maturity of the plan. This effectively reduces what is called price risk or the potential for making a loss on bonds due to pressures to sell them off in the market. FMPs are launched in series, back-to-back, with each scheme replacing the one that has just matured.

Do FMPs provide assured returns?

No, they do not. However, investors are informed the indicative returns their investments are likely to generate, along with the tenure of investment. The prevalent yield, minus the expense ratio, which varies from 0.25 to 1 per cent, will be the indicative return.

Who should invest in FMPs?

Investors targeting a return on their investments over a fixed period of time and are indifferent to market volatility within that period should invest in FMPs.

Where do FMPs invest?

FMPs usually invest in certificates of deposits (CDs), commercial papers (CPs), money market instruments, corporate bonds and sometimes even in bank fixed deposits. The quality of investment typically consists of highest rated paper.

What is the difference between FMPs and bank fixed deposits (FDs)?

FMPs are the equivalent of a fixed deposit (FD) in a bank, with a caveat: the maturity amount of a fixed deposit in a bank is guaranteed, whereas the maturity amount of an FMP is merely indicated.

How do I choose between an FMP and a bank FD?

FMPs hold an advantage over FDs in terms of tax-efficiency. A comparison of a one-year FMP (dividend option) and FD (for individuals) shows that the post tax returns are higher for FMPs than FDs; this is because dividends are tax free for investors though the mutual fund pays a dividend distribution tax of 14.16 per cent (12.5 per cent plus 10 per cent surcharge plus 3 per cent cess). In contrast, interest on FDs is added to the main income and taxed at the applicable income tax rate. For an individual with an income of over Rs.10 lakh, the tax in the case of interest on FDs is 34 per cent (30 per cent plus 10 per cent surcharge plus 3 per cent cess). The post tax returns are thus higher for FMPs as the tax incidence is lower.

Which FMP is more beneficial – one with a growth option or one with a dividend option?

FMPs with dividend options are beneficial for a maturity of less than s year. In the case of FMPs with a growth option and a tenure of more than a year, you may use the benefit of long term capital gains where the tax rate is 10 per cent (without indexation benefits) or 20 per cent (with indexation benefits). You may also avail a double indexation benefit if one invests in an FMP in March 2007 and redeems the FMP in April 2008. In such an event, the incidence of tax is further reduced.

What are the risks of FMPs?

Unless otherwise specified in the objective of an FMP, investments are in risk-free or highly-rated assets for principal protection. However, the following inherent risks exist:

Interest rate risk: FMPs are designed to protect you from interest rate risk. However, as a plan is launched and money is collected, interest rates can fall before the money is invested and the funds will have to be invested at lower rates.

Gapping risk: If the fund manager is unable to find assets with a corresponding maturity to that of the plan, this leads to risks of asset liability mismatch.

Credit risk: The credit portfolio in the plan may suffer if rating agencies downgrade ratings. Downgrades reduce the price of securities.