After the monetary policy committee's unanimous vote to hike benchmark rates for the first time in over 4 years by 25 basis points to 6.25%, investors will be better off by subscribing to FMPs as they can lock in higher rates. More so these debt funds provide marginally better return in comparison to bank fixed deposits owing to the indexation benefit that is allowed in case of long term FMPs held for over 3 years.
What are FMPs and how do they work?
Fixed maturity plans or FMPs are closed ended mutual fund schemes that invest in safer debt instruments with maturity timeframe same as the FMP. This means the FMP with a maturity of 1260 days will invest in instruments or instrument that matures within 1260 days or around the same time.
The funds are usually diverted across a set of debt securities that include G-securities, commercial paper, certificate of deposits, corporate bonds with high credit rating, money market instruments etc.
FMPs with 3-year maturity are more popular but the market also offers FMPs with 1 month, 3 month and other maturities up to 5 years.
It is to be noted that the underlying portfolio instruments that comprises the FMP scheme is held to maturity and hence it results in cost saving for the investor due to lower expense ratio.
How FMPs score over bank FDs?
First and foremost, FMPs protect investors against volatile interest rates and capital protection as the money is invested in debt instruments. Also in comparison to other fixed income instruments such as bank FDs or liquid and ultra short term debt funds, post tax return from FMPs is higher due to the indexation benefit that helps in lowering capital gains and hence lowers taxation liability.
In case when the FMPs are bought and sold in two different financial years, the benefit of double taxation can be availed to reduce tax liability substantially.
For FMPs held for over three years, long term capital gains tax @ 20% is charged with indexation or 10% without indexation is charged whereas in case when they are held for less than three years, tax as per the income tax slab of an individual applies.
Limitation of FMPs
The closed-ended nature renders FMPs unattractive and as a result investors have to duly account for their liquidity concerns before putting bet on such products. Though, such products can be traded on the exchanges where they are listed, trading in them is nearly negligible. Also, FMPs are subject to an element of risk of non-payment of some of the instruments it holds.