Monday, August 27, 2007

Dotting on FMPs in debt

Fact not Fad!
At a time when safety is on top of your agenda, Mutual Funds do not want to miss the bus! They have lined up a host of Fixed Maturity Plans (FMPs) with a mammoth Rs.23000 cr having been mopped up by 200 FMPs in just a couple of months. The case for you getting into the bus on time is strengthened by the fact that FMPs offer capital protection, at relatively lower cost with immunity from interest rate movements in a tax-efficient manner.
  • FMPs have less risk of capital loss than equity funds because they invest a lion’s share in debt and money market instruments.
  • FMPs involve minimum expenditure on fund management as there is no requirement for a periodic review by fund managers to buy/sell the instruments constituting the fund since these instruments are held till maturity.
  • Fluctuations in the interest rate and hence market value do not affect your returns from FMPs as securities in the portfolio are not traded but held till maturity.
  • FMPs are tax-efficient both in the short-term as well as in the long-term.

FMP is perhaps more popular with the populace than any other product that has hit the debt funds segment in recent times. FMPs are close-ended products, investing predominantly in debt and money market instruments, whose maturity coincides with the maturity of the product - ranging from a fortnight to five years. The objective is to lock-in the investment at a specified rate of return (in tune with the ruling interest rate scenario), thereby, immunizing the fund against market fluctuations. In effect, FMPs are structured to offer you capital protection (although implicitly). FMPs with a dash of equity (upto 20%) offer the twin advantage of capital protection (taken care of by the debt portfolio) and capital appreciation (provided by the equity portfolio).

Dazzling in the Debt Arena!!!
A plethora of debt instruments are available in the debt arena. Awareness of the nuances of debt instruments like Fixed Deposits (FDs), Monthly Income Plans (MIPs) and Capital Protection-Oriented Schemes (CPOSs) juxtaposed with FMPs will add light when you delve deep into the debt space. This enables you to make more informed investment decisions.
FMPs are akin to FDs issued by Mutual Funds instead of Banks. Though returns from FMPs are only indicative as opposed to guaranteed returns offered by FDs, FMPs end up yielding better post-tax returns than an FD with the added attractiveness of 'double indexation' benefit, which is not available in the case of fixed deposits. You can invest in an FMP before March 31 and withdraw it after April 1 the next year. This ensures the applicability of indexation benefits for inflationary changes in two years since the amount remains invested for a period slightly greater than a year. Double indexation, in some cases, can even lead to a net loss figure, even though there is a profit, and thus expunges your tax obligation. Moreover, interest from deposits of more than Rs. 1 lakh is taxed at the marginal rate making FMPs a better option for deposits of higher amounts. For short-term FMPs, Dividend Distribution Tax (DDT) of 14.1625% warrants the choice of dividend option whereas for long-term FMPs, growth option would be ideal since only 10% capital gains tax is applicable.
While an FMP offers an indicative return at the end of the term, an MIP professes to offer monthly income (albeit the same is not assured). While MIPs can hold as high as 30% of their assets in equities the maximum equity exposure is only 20% in FMPs. The uncertainty of the monthly income coupled with the increased exposure to equity boost the risk component in MIPs.
FMPs are structurally similar to but different in positioning to CPOSs that was the subject matter of the previous article. Both are structured products attempting to combine the stability of debt (at least 80%) along with the power of equities (around 20%). The debt component in both the cases enjoys a high credit rating (mandatory in the case of CPOS as opposed to FMPs). While FMPs are return-oriented investment avenues, they are not inclined towards protection of invested amount like CPOSs. CPOSs are close-ended in nature and do not offer any option for premature withdrawals. FMPs, on the other hand, have the option of prematurely exiting their investments by attracting an exit load as specified by the fund house.
FMPs score over other debt avenues like FDs, MIPs and CPOS, thereby, becoming the jewel in the crown in the debt space.
The billion dollar question now is …are FMPs for you? If you are well-versed with the concept of fixed-period investing, you may be more comfortable investing in products where there is time line to maturity than open-end debt funds. If you are looking for a fixed income avenue that yields a reasonable return with minimum risk, reasonable cost, adequate liquidity and tax efficiency, FMPs will provide you with the right answer.