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Friday, August 30, 2013

Fixed Maturity Plans - What to look for before you invest

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Fixed Maturity Plans (FMPs)



While FMP offer several advantages over other fixed income products when interst rates are rising, there are still certain factors that investors should keep in mind before taking the plunge. Here are a few of them...


Time horizon:

Remember although Sebi rules mandate that all FMPs should be listed on the bourses, the ground reality is that there is practically nil liquidity in these instruments since there are hardly any buyer or seller in the market. So as an investor if you are investing in an FMP, be sure that if you want the money even in case of even an emergency, you are unlikely to get that back then. Instead you have to wait till the day of redemption to get the money invested in that FMP in your bank account.


Match fund manager's investment horizon to yours:


In FMPs, the fund manager takes a time horizon for his/her portfolio of investments and he/she buys the instruments the time horizons for which perfectly match with the time horizon of the plan. The investor too invests with exactly the same time horizon. This is not the same in case of short-term income fund. In these funds even if you invest with say three or five years time horizon, the same as the fund manager at the time of entering, but after a year the fund manager may still maintain a three or five year time horizon, and would have churned his/her portfolio. On the other hand, after you have remained invested for a year, your time horizon is two or four years. This is one of the major differences between FMPs and short term income funds that investors should keep in mind.


Tax advantage:

Like most mutual fund schemes, FMPs too come with certain tax advantages. If you invest in an FMP which matures after more than a year, say even a 367-day FMP, you stand to gain from long term capital gains options under the income tax act. Under this option, you can pay a 10% tax without indexation, or 20% with indexation benefits. So clearly this makes sense if you are in the highest income tax bracket, which is you pay income tax at the rate of about 33%. If you are in the 10% bracket, then investing in FMPs may not make much of a sense because then you will pay the same rate of tax for FMPs as well as FDs, but by investing in FMPs you would have less liquidity.


Portfolio:

The portfolio of an FMP is an indication of the risks you are taking by investing in a particular plan. If all of the portfolio is invested in bank certificates of deposits (CDs), then the risks are much lower. On the other hand, if there are commercial papers (CPs), that are likely to add to the total risks associated with the FMP. Seen from the other side, having CPs in the portfolio may mean slightly higher rates. So as an investor before investing in an FMP you should have a clear idea about the risks you are willing to take, and accordingly you should settle for the returns that you would get at maturity.


Liquidity:

This is one disadvantage for FMPs, thay once you are invested in it, there is almost no way you can come out of its prematurely. So keep in mind that you put only that part of your fund in this better yielding and tax efficient instrument that you will not need till the time of maturity of the instrument.


Fund house:

Although all FMPs look like the same, offering nearly the same level of indicative yields, the fund manager and the fund house from which the FMPs are coming make a huge difference. If you are investing in the FMP of a good fund house, the risks associated with your investments are reduced significantly. This is more apparent at the current scenario when the bond market is extremely volatile and several cor porates are stretched to their limits.

Happy Investing!!

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You can write back to us at PrajnaCapital [at] Gmail [dot] Com

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