Fund houses line up FMPs

By Ravi Samalad |  14-04-21 | 
 
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Ravi Samalad is Assistant Manager - Editoral for Morningstar.in.

Fixed maturity plans, or FMPs, are making a comeback.

To cash in on rising yields and roll over investments from past FMPs maturing this year, at least five asset management companies have filed offer documents with Securities and Exchange Board of India, or SEBI, to launch FMPs in the recent past. In March 2021, SBI Mutual Fund launched two FMPs which mopped up Rs 1,100 crore.

Recently, Aditya Birla Sun Life Mutual Fund asked for extending the maturity of Aditya Birla Sun Life Fixed Term Plan six series: PG, PH, PE, OX, OY, PB, and PD.

“The massive bond rally in the previous year fuelled by aggressive rate cuts and accommodative stance of the RBI has pushed rates lower. Therefore, re-setting of maturities will offer an opportunity for investors of the respective scheme to get an extended long term capital gain benefit for their current investments,” states a notice issued by the fund house on April 1, 2021.

These schemes are set to mature during April 21-29. Investors who wish to remain invested in the existing schemes have to intimate the fund house 30 days prior to the maturity of the scheme.

The decision to remain invested or get out would depend on the liquidity needs of investors.

Why FMPs lost sheen

FMPs started losing sheen after the change in the taxation of debt funds. Investors now have to wait for three years to avail long-term capital gains tax and get indexation benefit. Indexation allows investors to lower their capital gains (thereby pay lower tax) by adjusting the purchase price for inflation. The long-term capital gains tax rate too was hiked from 10% to 20% in Budget 2014.

Also, revenues on FMPs are wafer-thin for fund companies. SEBI permits AMCs to charge a maximum of 1% TER in FMPs. However, AMCs charge anywhere around 30 basis to 40 basis point to offer competitive returns as higher TER eat into returns. The TER in direct plan is even less than that of regular plans. Further, fund companies can only pay trail commissions in such schemes; no upfronting of commissions are allowed. Thus, FMPs launches had come to a grinding halt due to a combination of these factors. The industry currently has 582 FMPs which collectively manage assets worth Rs 1.19 lakh crore as of March 2021.

Where do they invest

As the name suggests, FMPs invest in securities that mature on or just before the maturity of the scheme. The tenure of the scheme is disclosed in advance in the scheme name, which could range from a few months to years.  These funds invest in a mix of government securities, PSU & corporate bonds and money market instruments maturing on or before the maturity of the scheme.

Since these are closed ended schemes, the money is locked in for the scheme tenure.  They are listed on the exchanges and one may exit through the secondary market. However, the net asset value, or NAV, of the scheme might be trading less than the scheme NAV due to lack of liquidity. Since the schemes are listed on exchanges, no exit load is charged.

Risk

The interest rate risk in such funds is usually low because fund managers hold the paper till maturity. However, credit risk exists as the paper issued by firms could be downgraded or default. It is worth noting that a few FMPs which had invested in bonds floated by Essel Group, Zee Entertainment Enterprises Ltd., and IL&FS Ltd. entities had to roll over as the creditors had failed to make repayment on a few bonds.

To tackle such issues, SEBI has overhauled the investment norms for debt funds. For instance, the total exposure towards credit enhancement/structured obligations such as corporate/promoter guarantee cannot exceed 10% of debt portfolio of the scheme and group exposure should not exceed 5% of debt portfolio of the scheme. Further, these funds do not invest more than 10% of NAV in instruments issued by a single issuer, which are rated not below investment grade.

Should you invest?

Financial advisers say that retail investors should steer clear of such funds. “I usually do not recommend FMPs to my clients mainly because they are closed ended funds and the money is locked in. As long as the fund manager has done his research well and chosen credit-worthy bonds, the risk associated with an FMP is lower than an open ended debt funds. This is because you know the maturity of the underlying paper held in FMPs. However, as credit ratings are not constant and trouble may face us at any time in case of default or downgrade, FMPs may turn to be riskier than open ended mutual funds. Also, instances of rollover which started in 2019 could be highly risk for investors. Even if AMCs recover money from any defaulted or downgraded borrower, the yield will reduce drastically due to the fall in NAV and it takes weeks or months to recover the original level of NAV,” points out Bengaluru-based RIA Basavaraj Tonagatti.

Some distributors say that it is better to opt for open ended debt funds to avail indexation benefit.

“If you invest for three years in FMPs, you get the money back at maturity and have to redeploy the corpus. Thus, your three year holding period starts all over again in order to avail indexation benefit. As opposed to investing in FMPs, if one has invested in open end debt fund for four years, the indexation benefit continues without having to get in and get out of funds. Further, over the long run, dynamic bonds and gilt funds have delivered better returns than FMPs. Since these are closed ended funds, there is illiquidity. There was no surety of the quality of the paper. Also, the yield on FMPs have fallen now as compared to a few years back,” says Mumbai-based distributor Vinod Jain.

Bengaluru-based MFD Srikanth Matrubai believes that investors face reinvestment risk in such products. "These products are not transparent enough for my comfort. If I have to take the risk I prefer taking it in equity, not debt," says Srikanth.

FMPs are often compared with bank fixed deposits. But the features of these two products are vastly different. Banks offer assured rates while FMP returns are indicative. Further, FMPs come with credit risk. On the other hand, investors get principal and interest up to Rs 5 lakh under the deposit insurance scheme if a bank discontinues its operations. Also, do note that liquidity is restrained in FMPs (though once can exit from the stock exchange) while you can close your FD by paying a penalty. Do note that tax-saving FDs falling under 80C do not allow premature withdrawal. Where FMPs score over FDs is indexation benefit, which results in paying lower taxes.

Consult your financial adviser to understand how these funds fit into your risk appetite and goals.

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