Why should I invest in Fixed Maturity Plans (FMP)
Fixed Maturity Plans (FMPs) are close-ended mutual fund schemes with a fixed maturity date. Such funds automatically redeem the investments on a particular date. For example, 1100-day FMP will be redeemed at the end of 1100 days from the date of allotment of units. To the extent possible, the duration of the underlying securities is matched with the FMP duration, in order to mitigate the interest rate risk to a large extent. So, the fund manager of an 1100-day FMP will tend to invest the investor’s money into securities of equal or slightly lesser duration and then adopt ‘buy and hold’ strategy.
Benefits of ‘Buy & Hold’ Strategy
So now that you know, what is FMP, let us also discuss about the securities where your funds may be invested. An FMP portfolio is a typical debt portfolio and will include investments in Non-Convertible Debentures (NCDs), bonds, Government Securities (G-Secs), Commercial Papers (CPs), Certificates of Deposits (CDs), Treasury Bills (T-Bills) etc.
‘Buy and hold’ strategy helps the investors to lock in the prevailing yields for their investment period, as any movements in the interest rates between the investment period are immaterial to the investor and by the time the FMP matures, the underlying securities have also matured, thereby eliminating any valuation gaps. The investors in absence of any credit event may reasonably expect the fund returns over the period to mirror the prevailing Yield-To-Maturity (YTM) at the inception of the scheme.
Entry into & Exit from FMP
The investors can invest in FMPs during the New Fund Offer (NFO) or through stock exchanges during the investment period of such FMP. Similarly, being a close-ended scheme, the fund houses cannot redeem the investments before the maturity date. However, FMPs are listed on stock exchanges to provide an exit window to the investors.
FMPs v/s Fixed Deposits
FMPs can be compared to the investment in bank fixed deposits of similar duration, as both the investments mature at a specified date. However, since FMPs invest in a basket of fixed income securities including bonds, the returns may likely be higher than the deposit rates of commercial banks. As such, investors can enjoy the benefit of higher returns with minimal market risk by investing in FMPs. However, it must be noted that the FMPs do not offer guaranteed returns, but having said that, the expected returns may be reasonably forecasted.
Tax Efficient Returns through FMPs
The FMPs are liable to be taxed in line with the tax treatment of the gains from debt funds. Further, FMPs may be so designed to provide you the tax advantage in terms of indexation benefit. The benefit of indexation under the Income Tax Act allows the investors to adjust the cost of the investment in line with the Cost Inflation Index (CII), as notified by the Central Board of Direct Taxes on an annual basis.
For example, an 1100-day FMP launched on 30th March 2019 will mature on 3rd April 2022 and hence, provide you with indexation benefit for 4 years, as the investment period spreads over 4 financial years. As such, the returns to the extent of invested amount, as adjusted for inflation index for 4 years, will stay out of tax net, and any additional returns over and above such amount will only be taxed as long-term capital gains from debt funds. This is how an FMP investment may help you in generating tax-efficient returns.
Considering the tax-efficiency of long-term FMPs and the currently prevailing yields, it makes sense to consider investing in FMPs to generate better returns than regular fixed income portfolio.