Till recently, fixed maturity plans (FMPs) were being marketed to investors as a low-risk alternative to fixed deposits (FDs). But reality hit last month when investors in the Kotak FMP 183 Series received less than the face value of Rs10 per unit on the maturity of the fund after three years of staying invested, with the promise of more, but only if the promoters of Zee Entertainment Enterprises Ltd pay up on their obligations in September 2019.
HDFC Mutual Fund also gave investors the option to roll over the scheme or extend the maturity of one of its FMPs by 380 days, which was due for redemption on April 15 2019.
The crisis highlights the hidden risks in investing in FMPs. If you are a new investor who is considering putting money in FMPs this year, read here to know the instrument better, rather than thinking of it as a substitute of FDs.
What are FMPs?
— Fixed maturity plans (FMPs) are a special class of close-ended debt mutual funds that mature after completion of a pre-determined time period. Thus you can make investments in an FMP only during the new fund offering (NFO) period. Once the NFO period closes, no new investments can be made into the scheme.
— Also, FMP investments can be redeemed only after the scheme matures and no premature redemption of units are allowed during the interim. The maturity period of a FMP is pre-fixed and once you have invested through NFO, your investment is essentially locked-in till maturity.
— Based on the duration of the scheme, the fund manager allocates your money in instruments of similar maturity. For example, if an FMP is for five years, then the fund manager invests in a corporate bond having a maturity of five years.
— FMPs usually invest in debt instruments like a certificate of deposits (CDs), money market instruments, corporate bonds, commercial papers (CPs) and bank fixed deposits.
Benefits of fixed maturity plans
— A majority of the investments made by FMP schemes are held till maturity, hence these instruments have low levels of interest rate sensitivity. In effect, FMP investments allow you to lock-in interest rates for longer periods of time, which can be beneficial during a period of falling interest rates.
— A majority of new FMPs feature a maturity period of three years or more. This ensures that long- term capital gains taxation rules, including indexation benefits, are applicable to capital gains from these non-equity investments. Indexation provides investors the benefit of factoring in inflation, which reduces overall tax liability on gains.
Limitations of fixed maturity plans
— Since redemption of scheme units cannot be made prior to the maturity of the FMP schemes, these funds have potentially low levels of liquidity.
— While locked-in rates are an excellent choice during a falling interest rates regime, the same can become a problem during a period of rising interest rates. When market rates move upwards, locked-in rates can lead to missed opportunities with respect to potentially higher returns coupled with possibly lower risk levels.
— FMPs provide investors with the benefit of locked-in returns from instruments held till maturity. High-quality investments minimize credit risk for investors. But the low potential risk does not mean zero risks for the investors and returns from FMPs are still market-linked. As a result, returns from FMPs are not guaranteed unlike other fixed return instruments such as FDs.
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