Fixed Maturity Plans: Should You Invest In Them Now?

Now when the RBI has increased the repo rate to a solid 6.5% which is further transmitted by banks to investors offering higher fixed deposits and recurring deposit rates for various terms. However FDs and RDs do seem attractive to invest, but they are not tax efficient. The interest earned is taxable as per the income tax slab. There is an FD equivalent investment option called fixed maturity plan, which also has a fixed term of investment but is tax efficient.

What is a Fixed Maturity plan?
A fixed maturity plans (FMPs) are close ended debt mutual funds that have locked the investment term. These plans allows investors to invest only when they are open for a few days during the launch of the scheme and then closed until maturity that can range from one month to five years. Besides, an investor can trade his /her FMP unit fr liquidity purpose.

Fixed maturity plans invest in debt instruments such as corporate or Government bonds, commercial papers (CPs), certificates of deposit (CDs) and other money market instruments maturing in line with the scheme. The maturity term can vary between few months to a few years.

How do FMPs work?
As mentioned earlier FMPs have fixed maturity term, that means it locks the yields. If the investors hold on to their investment till maturity FMPs, the fluctuation in interest rate risk is minimalized and would allow them to typically lock in the yields prevailing at the time of NFO launch, subject to re-investment risk and scheme expenses. It leads to aversion and insulation of portfolio yields from the changes in the interest rates during the tenure of scheme.

For example, while constructing a portfolio of a FMP with three years term, a fund manager will choose debt instruments having a maturity of 3 years, falling not later than the maturity date of that FMP. Investors investing in such a scheme will get the yield locked by the instruments held in the portfolio for three years.

Features
An FMP has following features.

• Fixed term period: A fixed maturity term locks an investor's funds till the end of the term once an investor invests through NFO.
• Close-ended scheme: No additional investment in this scheme is allowed post the NFO subscription period.
• Limited rate sensitivity: Large portion of investment in FMPs are held till maturity to lock-in interest rates for a longer duration, and this helps investors whenever interest rates fall.
• Low credit risk: Most of the FMPs investments are made in high quality debt and money market papers, including treasury bills and government bonds.
• No Guaranteed returns: FMPs do not guarantee returns, as they lock the prevailing yield of securities at the time of investment.

Benefits
Investing in an FMP has the following three benefits.

1. Tax efficient
Only if an investor remains invested in this scheme for more than three years, long-term capital gains realised on selling the units after a holding period of three years are taxed at a rate of 20% after indexation.

2. Stability
As FMP investments are locked in for a pre-decided term, so when the investment goes through various market movements, it allows the fund performance to stabilise over time. FMPs get rarely minimally affected by market movements especially during the falling interest rate scenario.

3. Lower Risk
Compared to equity investment FMP are less risky, interest volatility is negligible, but credit risk, market risk and liquidity risk still does prevail.

When to choose FMP?

FMP is suitable for investors who are conservative but want to earn relatively higher returns than a bank FD or tax-free bonds. Also these are ideal for investors who do not want to time the interest rate cycle or want to be safe from interest rate risk would rather keep their investments locked in close-ended FMPs, it would yield superior rates.

Besides, note the caveat being that the investments held for more than 3 years will get the benefit of tax- efficient returns compared to FDs.