Fixed Maturity Plans are closed-end debt mutual fund schemes that invest in fixed-income instruments with a defined maturity period. They are very popular among investors seeking stable returns with relatively low risk, especially those looking for alternatives to traditional fixed deposits (FDs). Here’s an in-depth look at what FMPs is, how they work, and the reasons to consider investing in them.
What Are Fixed Maturity Plans (FMPs)?
FMPs are investment products provided by the mutual fund that are particularly based on debt and money market instruments such as bonds, government securities, commercial papers, and certificates of deposit, among others. These investment instruments are chosen in accordance with the tenure of a scheme, which may be from a couple of months to a couple of years.
FMPs have a fixed maturity date, meaning the investment tenure is predetermined and aligned with the underlying assets’ maturities. For instance, a three-year FMP will invest in debt instruments that mature in three years, allowing the entire portfolio to mature at the end of the term, thereby minimizing interest rate risks and providing a predictable return at maturity.
How Do Fixed Maturity Plans Work?
When you invest in an FMP, your money combines with that of other investors who are invested in a diversified fixed-income security portfolio aligned to the maturity of the particular plan. Returns are set at the time of interest rate when these instruments are purchased. As the FMPs are closed-end funds, investment is only possible during the fund’s initial offer period and, as a general practice, the units are locked-in till maturity. But in the case of FMPs, being listed on the stock exchanges, some liquidity is available for exit at the hands of the investor if he wishes to before maturity.
FMPs are the kind of instruments that protect a person from the volatility in interest rates because they carry the instrument till maturity. They do not have to mark-to-market as open-ended debt funds do and, hence, are less vulnerable to daily fluctuations in interest rates. The returns, therefore, are more predictable though not guaranteed.
Why Invest in FMPs?
Here are some reasons why FMPs may be an investment avenue for you:
FMPs are less volatile in terms of returns because they invest in fixed-income securities and hold them until maturity. They eliminate the need to buy and sell securities during the term, which eliminates interest rate volatility, giving a better idea of what the returns might be. That is not to say that returns are guaranteed, although they are more stable.
Tax Efficiency:
FMPs are tax-friendly as compared to fixed deposits, especially for long-term investors. FMPs attract long-term capital gains tax if held for more than three years, which is lesser than the tax on FD interest. Indexation benefits the investor since it adjusts the purchase price of units for inflationary conditions and, therefore, reduces taxable gains. This may lead to substantial tax savings for investors in higher tax brackets.
Low-Interest Rate Risk:
As FMPs invest in the instruments until maturity, they are not sensitive to interest rate fluctuations. In contrast, open-ended debt funds are sensitive to daily interest rate fluctuations that could negatively impact returns if the rates move against the position of the fund. A “buy and hold” approach of FMPs stabilizes returns and shields investors from interest rate risk.
Diversification and Professional Management:
FMPs invest in diversified portfolios of debt instruments so that risk is spread; these funds are professionally managed by fund managers who select, based on credit ratings, market conditions, and interest rates, the best securities, which can help maximize their returns and reduce risks. Though the risk is lower in FMP than in equity investments, because of professional oversight, chances of default are brought further down.
Better Returns than FDs:
FMPs typically offer returns roughly around or a little above the fixed deposits, unless there are sufficient interest rates and the quality of the underlying assets is good. Investors then receive a higher potential return with the same stability. This is particularly attracted when the Bank FD rates are low.
Alternative to Traditional Investments
FMPs are suitable for conservative investors wishing to invest in alternatives apart from traditional investments such as FD, recurring deposits, or saving accounts. They form an intermediate category with a mixture of fixed-income and tax-efficient growth potential, thereby rendering them a better choice for the long-term, tax-aware investor.
Some Critical Pre-Investment Considerations Related to FMPs
Even though FMPs carry many benefits, here are some things to consider before investment:
Lack of Liquidity Since FMPs are closed-end funds, they cannot be sold before maturity. Although the stocks are listed on an exchange, trading volumes are typically low, resulting in a lack of liquidity. Be prepared to hold the investment until maturity.
Credit Risk: Though FMPs normally are invested in top-grade instruments, there still exists the risk of credits. Upon default by an issuer, this would negatively impact returns to the FMP. The credit quality of securities in the FMP’s portfolio needs verification.
Returns Not Guaranteed: FMPs are not guaranteed for returns like fixed deposits. Though returns are predictable in nature, they are based upon the interest rates of underlying securities and hence subject to some variation.
Who to Invest in FMP?
FMPs are suitable for investment by individuals who have,
Low to moderate risk appetite but require stable returns.
The need to invest for a fixed period, generally over medium- to long term for financial goals.
Are in higher tax brackets and looking for tax-efficient fixed-income investment options.
Need a middle-ground investment between high-risk equities and low-return fixed deposits.
Conclusion
Fixed Maturity Plans are a very valuable investment choice for risk-averse investors who want stable, tax-efficient returns with a fixed investment horizon. They provide predictable returns with low-interest rate risk and are much more tax-efficient than fixed deposits, making them very attractive in a low-interest environment. Yet the investor must be prepared to hold the investment till maturity and must scrutinize the credit quality of the underlying assets. Knowing how FMPs work and risks associated with them makes a great fit for conservative portfolios that are looking for stability and tax savings.