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Monday, January 20, 2014

Lock your returns in FMPs to avoid interest rate risks

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Fixed maturity plans (
FMPs) are typically closed-ended funds belonging to the debt category of mutual funds. These schemes carry a fixed term of investment, and when the term ends, the proceeds (principal plus returns) will be automatically redeemed and deposited in the investor's bank account.


In FMPs, fund managers take investors' money and deploy them in debt securities like bank CDs (certificates of deposits), commercial papers, corporate bonds and sometimes even in bank fixed deposits and hold these securities till maturity. They ensure investing in papers that have a maturity date aligned with the maturity date of the FMP.

When to invest in FMPS?

The recent volatility witnessed in debt markets has shown that it is not just the equity market but also debt investments that require careful considerations. It is especially during current times – when no one is aware of the direction in which the interest rate in the economy will move – that low-risk opportunities such as FMPs could prove to be a good place to put money in.


FMPs aim to invest in debt securities with high yields and stay invested in them till maturity to give the benefit of high interest income to its investors. A number of fund h o u s e s h ave re c e n t ly launched FMPs to make the best of the high yields prevalent in the debt markets today.

FMPs are tax-efficient compared with bank FDs

Historically bank FDs, due to their guaranteed interest rate and capital protection, have been a popular investment vehicle among Indian investors. However, due to lack of knowledge among investors about other alternative products like FMPs (often considered as the MF equivalent of FDs), investors have not benefited fully from such investment instruments.


FMPs get tax treatment of debt mutual funds. Thus, investment in FMPs of more than a year's duration provides indexation benefit – a benefit that is given to debt investors to compensate for the loss in real income due to inflation. Thus, individuals in higher income tax brackets can get better after-tax returns from FMPs than from FD products that do not provide such benefits.


FMPs also give a double indexation benefit. That is, if you plan your investment in such a way that you stay invested for two financial years (not necessarily for two years or 730 days), you get to enjoy double-indexation benefit. And what's even better, if after double indexation you incur a loss in your investments, you can set off those losses against any other short- or long-term capital gain over the next eight years.

FMPs are neither liquid nor do they guarantee returns

Though FMPs have their benefits, finding one with a duration that fits your investment need should be your first consideration as these are closedended funds. That is, they do not allow redemption before the maturity date. Also, if you want the best out of your FMP, you have to stay invested till its maturity to realize its full potential.


Although investors can go to the stock exchanges in case they want to sell their FMPs prematurely and get out, the fact is there are hardly any or no buyers. Premature withdrawal may also not give you the same yield and, in the worst case, it may even result in a loss.


Another point to note is that while FDs provide a guarantee of a certain percentage of return, FMPs are not allowed to do so. However, since FMPs take investors' money and invest them in debt securities and hold these securities to maturity, one can mostly expect to get returns on a par with the existing market interest rates at the time of investment. In market parlance, this is called the indicative yield. However, the fund does not guarantee you any rate of return

 

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