What are FMPs FMP is equivalent to a Bank FD in a mutual fund but unlike FDs it cannot offer a fixed return. However, by nature the returns on the FMP are locked as all the investments are held to maturity. As the name denotes, the maturity of securities in portfolio equates with maturity of the FMP. They fall under the closed ended debt category of mutual funds which has exposure only to fixed income securities for different maturity periods. The primary objective of a FMP is to generate income and protect fluctuation in the capital due to interest rate variations. They are also known as fixed tenure funds and fixed horizon funds. 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 till 3 years. The different maturities provide an option to investor to choose an FMP as per their investment horizon. Also one important point to note here is that unlike other debt funds, the fund managers do not need to undertake the review of portfolio because the instrument in portfolio matures with the tenure of the scheme. Thus, the expense gets reduced to a great extent. How FMPs score over FDs The biggest differentiator between a Bank FD and an FMP is the Income Tax Arbitrage opportunity available. FMPs (if you have opted for Growth option) is taxed as capital gains and if you have opted for dividend option, it attracts Dividend Distribution Tax (DDT). Please refer to our earlier article on Taxation on Debt Funds. The below illustration explains how one can optimize their tax liability: Investment of Rs.1,00,000 in FMPs & Bank FDs for period of 1 year Bank FD Rs. FMP Rs. Investment Amount (A) 1,00,000 1,00,000 Returns (% per annum) (assumed) 9% 9% Time Horizon 367 days 367 days Maturity Amount (B) 109049 109049 Interest/Capital Gain (C) = (B-A) 9049 9049 Cost after inflation with indexation (100000 )*924/852 (D) NA 108450 Net Taxable Income with indexation (E) = (B-D) - 599 Tax Payable (assumed 30.9%) on Bank FD (F) 2,796 - Capital Gains (@ 10.3% of (C) without indexation - 932 Capital Gains (@ 20.6% of (E) with indexation - 123 Post tax Return (C F) 6253 8926 Post Tax Return (%age) 6.25% - Post Tax Return- with indexation (%age) - 8.93% *Cost Inflation Index (CII) for 2011-12 -785 and for 2012-13 -852, it is assumed cost inflation will rise by 9% as in the past. Capital gains tax is 10% or 20% with indexation whichever is less On pre tax basis one is not able to make out which investment avenue is better, but as seen in the above example the impact after reducing taxes is indeed very significant. An investor can get 42% more return than a FD. The FMPs are best suited for investors (specifically in the tax bracket above 20%) who are looking for a risk free investment avenues. Options to choose from are as under: Tax Bracket Holding Period Less than 1 year More than 1 year Up to 20% Growth Growth 30% Plus Dividend To conclude although bank FDs offer guaranteed returns and FMPs cannot, there is merit to invest in FMPs vis-a-vis FDs due to higher tax efficient returns offered by FMPs. However, there is one limitation with regard to liquidity. Even though these are listed on the Stock Exchange, there is no liquidity and typically the investor has to hold the investment till maturity. Presently, investors could look at FMP as a suitable investment option in the current environment. In the past few weeks, the fixed income landscape in the country has changed drastically. Following the unprecedented liquidity tightening measures by the RBI in response to the sliding rupee, short-term rates have jumped up sharply. This has increased the attraction for investments in short-term debt instruments, such as the one-year certificates of deposit and commercial paper. The rates have risen to 9.5-10% for certain instruments, up to 150 basis points higher than that a month ago, when sliding interest rates had increased the preference for longer tenure instruments. The fund houses have been quick to take advantage of the short-term rates, with nearly all AMCs launching fixed maturity plans (FMPs) of different tenures in the past month and current month. The investors who lock in money at the current level should enjoy double-digit returns over a one-year horizon, 2year and 3 year horizons.
Posted on: Sun, 25 Aug 2013 03:14:37 +0000
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