With interest rates inching up, fixed maturity plans, now better regulated, are back in vogue
Due to high inflation, the government has adopted a mildly hawkish monetary stance as a part of its exit from the monetary stimulus extended earlier. Interest rates are expected to inch up further which means fixed-income products will make a good bet for the risk averse.
In this scenario, fixed maturity plans (FMPs) offered by mutual fund companies have come back on the radar of investors who seek safety with slightly higher returns than bank fixed deposits (FDs). FMPs not only provide a safer avenue for investing compared to equities or equity mutual funds, but they also provide tax benefit, beating most fixed-income products in terms of post-tax yield.
The risk is lower in FMPs, since most of the corpus is invested in debt papers of highly-rated companies. FMPs also offer the benefit of 'double-indexation', wherein returns on FMPs with tenure of more than one year are eligible for inflation indexation; the tax incidence amounts to only 11.33% without indexation and 22.66% with indexation. As such, they beat post-tax returns of fixed deposits by a sound margin, as FDs are taxed at the highest tax rate of 33.99% for investors who fall in that tax slab.
On the flip side, FMPs offer returns which are only indicative and not guaranteed. Also, some FMPs invest a small portion of their corpus in equities that exposes the investor to some degree of risk in a falling market. Even a 10% exposure to a free-falling equity market would erode the entire returns. Until only a few years ago, FMPs were plagued by several problems which we have highlighted in the past. In a bid to grab investors' attention, several FMPs followed the unhealthy practice of offering higher indicative returns by investing in low-quality paper that yielded much higher returns. Credit quality received scant preference, exposing investors to greater risk. Some FMPs tried to offer higher returns by going in for longer tenure paper (which offered higher yield) regardless of the maturity period of the scheme. At the time of maturity of the paper, if interest rates were high, fund managers would end up selling the paper at a loss before the scheme matured.
The real stench in the FMPs surfaced in the crisis year- 2008 - when the stock markets went into a freefall and savvy investors wanted to redeem their FMP investments. This exposed a can of worms as investors found themselves shortchanged when redemption pressures mounted in September-October 2008. The 'indicative returns' mostly turned out to be myths and many fund houses imposed restrictions on redemption. In many cases, investors couldn't even make sense of the underlying securities. Many FMPs attracted investment by indicating one basket of securities and actually invested in an entirely different set of riskier securities. Some FMPs were launched to invest only for one or two bonds of risky real-estate companies! The Securities and Exchange Board of India (SEBI) tried to address many of these issues through a new set of guidelines in 2009. Apart from making it compulsory for FMPs to list on the stock exchanges, SEBI banned the practice of FMPs announcing indicative returns and displaying indicative portfolios.
Given the tighter regulation, favourable economic circumstances and benefits offered, does it make sense now for retail investors to buy FMPs? We believe it does, provided investors enter such plans with the intention of staying on till maturity. Otherwise, you may have to sell units at a discount as these schemes lack liquidity as before. Exiting before maturity is more difficult as the units are now listed on stock exchanges. Also, investors should go in for an FMP with a maturity period that matches their own investment requirements. When deciding on which FMPs are good, go for fund houses that have a consistent high quality of track record as a whole. — Moneylife Digital Team
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