Mutual fund advisors are busy recommending three-year fixed maturity plans (FMPs) offered by asset management companies to investors. According to these advisors, investing in FMPs at this juncture make sense as investors can benefit from the `double indexation’ benefit .
“If you invest in a three- year FMPs before March 31, you will actually be holding it for a period slightly above three years. At the time of maturity, you will be eligible to claim indexation benefit for four years instead of three years,” says Prashant Maurya, Partner, Citrine Financial Advisors.
This will increase the cost of purchase and a higher purchase price will help to bring down the capital gains and taxes.
FMPs are closed-ended funds which invest in debt securities. These instruments have defined maturity.
Mutual fund houses are busy floating FMPs with a tenure slightly above three years or 1095 days. The idea is to provide additional taxation benefit to investors.
Suppose Investor A had invested Rs 1 lakh in a three-year FMP in April 2014 and an investor B invested the same amount in a three-year FMP in March 2014. Both had their maturities in April 2017. In this illustration investor A is holding the FMP through three financial years, whereas investor B is holding his FMP through four financial years. Their cost of purchase will be calculated as follows:
In the above illustration, as investor B is getting indexation benefit for four years, his indexed cost of purchase is higher than investor A who is getting indexation benefit for three years. Higher cost of purchase means lower capital gains, and lower tax.
FMPs are suitable for those who want to avoid interest rate risk or are willing to invest in safer debt instruments which would earn marginally higher than savings account and bank fixed deposit.
FMPs usually invest in securities which match their tenure and follow buy and hold till maturity strategy. This makes it free from interest rate risk. An FMP may match the yield offered by its portfolio constituents with minute deviations.
However, FMPs are not without any risk.
They lack liquidity. “Investors may sell these on the stock exchanges before lock-in ends, but usually these are either thinly traded or are traded at deep discounts,” says Prashant Maurya.
FMPs also have credit risk. “FMP returns will be hit if any security held in its portfolio face rating downgrade,” says Ankita Tanna Narse, founder, Oaktree Financial Advisors. Also, if interest rate starts going up, investor who has locked in his or her money in an FMP might lose on an opportunity to earn higher interest on investments.
Advisors ask investors to understand the indicative portfolio holdings and investment pattern of an FMP before investing in it. “It is not very difficult to gauge the portfolio quality. Study the indicative investment pattern and quality of portfolio before you choose one. It is mentioned in the Scheme Information Document,” says Ankita Tanna Narse.
