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Fixed maturity plans are type of debt fund where the investment portfolio is closely aligned to the maturity of the scheme. AMCs tend to structure the scheme around pre-identified investments. Further, like close-ended schemes, they do not accept money post NFO (New Fund Offer). The characteristic of FMP is such that they are passively managed by the fund manager.
FMPs are somewhat different than a fixed deposit in a bank. FMPs are debt schemes, where the corpus is invested in fixed-income securities. Even though, FMPs may have an exposure to high quality debt securities, FMP’s returns are not ‘guaranteed’. Predominantly, because the fund house knows only the interest rate of the securities that the FMP will earn on its investments.
How do they work?
The basic objective of FMPs is to generate steady returns over a fixed tenure, thus shielding investors from interest rate fluctuations. FMPs achieve this by investing in a portfolio of debt securities [predominantly certificate of deposits (CDs) and commercial papers (CPs)] whose maturity or tenure matches with that of the scheme. These securities mature on or before the end of the FMP term.
For example, if the FMP is for 12 months, the fund manager will invest in instruments with a maturity of 12 months or less. Since FMPs are closed ended and investors cannot redeem units with the mutual fund during the FMP tenure, the fund manager need not sell any part of the portfolio (to provide for redemption) during this tenure thus locking the yield of the portfolio. This also mitigates the risk of loss on premature sale of securities and lowers the interest rate risk. However, the investors have the option to redeem the units of FMPs on the stock exchanges, where the FMPs are listed, and hence may impact the portfolio’s return to the extent of redemptions received. Also, the fund manager at his discretion may churn the portfolio of the FMP in order to get a better yield.
FMPs, however, are not allowed to provide 'indicative yields' to investors like in the case of FDs, where interest rates are pre-defined. However, in a rising interest rate environment (as is currently prevailing), FMPs will inherently capture this trend.
Where do they invest?
FMPs have exposure to high quality bonds (generally AAA/AA rated). As FMP being a debt fund, the portfolio is more tilted towards fixed income securities like certificate of deposits (CDs), commercial papers (CPs), Corporate Debt, floating rate instruments, pass through certificates (PTC), money market securities, government securities etc. The exposure across different debt instruments makes it more attractive and reduces the portfolio risk.
The FMP comes with different maturities like 1 month, 3 months, 6 months, 1 year, 3 years or even more. The different maturities provide an option to investors to choose an FMP as per their investment horizon.
Tax Advantage
Fixed Maturity Plans scores high on tax advantage when they are compared to similar instruments like Fixed Deposits (FDs). In FDs the interest earned is added to the investor’s income and taxed at individual personal income tax rate. Interest from Fixed Deposits is categorized as ‘Income from Other Sources’ under the Income Tax laws. In the case of FMP, the tax implication depends upon the investment option chosen – Dividend or Growth
Which option should you choose?'
- Dividend Option: Dividends in FMPs are tax free in hands of investors. However, Mutual Fund companies have to pay a Dividend Distribution Tax (DDT) of 25% plus surcharge and cess for Individuals and HUFs (28.325%) and 30% plus surcharge and cess for others (33.99%) before distributing it to investors.
- Growth Option: If any investor opts for Growth option, he is subject to Capital Gains Tax. Short Term Capital Gains (if units are held for 12 months or less) are taxed as per the Tax Slab Rate. For Long Term Capital Gains (if units are held for more than 12 months) are taxed at 10% without indexation or 20% with indexation. The indexation benefit inflates the cost of purchase lowering long term gains tax liability, which is not the case of FDs.
The length of the holding period matters, especially when one has to decide between growth and dividend options. Investors can go for the growth option if the holding period is more than a year and for the dividend option if the holding period is less than a year.
|
| Fixed Deposits | FMP (with Indexation) | FMP (without Indexation ) | |||||
| Investment Amount | 100,000 | 100,000 | 100,000 | |||||
| Return | 9.00%** | 9.00% | 9.00% | |||||
| Duration of investment in Days | 368 | 368 | 368 | |||||
| Maturity Value | 109,074 | 109,074 | 109,074 | |||||
| Inflation rate of indexation* | N.A. | 10.05% | N.A. | |||||
| Indexed Costs* (Single Indexation) | N.A. | 110,050 | N.A. | |||||
| Taxable Income | 9,074 | -976 | 9,074 | |||||
| Tax Rate | 30.90% | 20,60% | 10,30% | |||||
| Tax on Interest Income | 2,804 | 0 | 935 | |||||
| Post Tax Gain | 6,270 | 9,074 | 8,139 | |||||
| Post Tax Return (Annualized) | 6.22% | 9.00% | 8.07% | |||||
| Cost of Inflation Index | |||
| 1981-81 | 100 | ||
| 2009-10 | 632 | ||
| 2010-11 | 711 | ||
| 2011-12 | 785 | ||
| 2012-13 | 852 | ||
| 2013-14 | 939 | ||
* The last 5 year simple average indexation is at 10%, hence we have assumed a 10% indexation cost for estimation.
** 1 year SBI FD rate
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