Fixed maturity plans (FMPs) have fixed opening and maturity dates, and if they are held to maturity, they can give predictable returns like fixed deposits (FDs). So are FMPs immune to the current market risks and also are they a better alternative to FDs?
FMPs are exposed to a lot more credit risk than FDs. As aggressive credit bets in FMPs soured, the industry turned away from them. Launches of closed-end funds (most of which are FMPs) plunged from 526 in FY19 to just 94 in FY20, data from Pulse Labs, mutual fund analytics and research firm, showed.
The case of Kashinath Chaudhari, 61, a retired textile worker in Surat illustrates the depth of the mis-selling problem. Chaudhari was sold a close-ended hybrid fund. This sort of fund invests in equity and debt and is not an FMP. However, the trouble with this scheme happened on its debt component, from a default that also hit pure FMPs. “We received a postal life insurance cheque of around ₹4 lakh, on the death of my mother. After they cleared the cheque, SBI branch officers called my father to the branch. They told him to invest in this product because it was just like an FD and would give 10% interest and would not have any tax deducted at source (TDS) or tax payable on maturity," said his son Mihir Chaudhari.
The fund, SBI Dual Advantage Fund Series XXII, was launched on 24 May 2017 and is set to mature on 27 May 2020 with a compounded annual growth rate (CAGR) return of just 2.22%.
So how should investors look at FMPs? These have four advantages. First, by investing in corporate debt, they can give slightly higher yields than FDs. Second, if held to maturity, the returns are predictable. Third, they are more tax-efficient than FDs due to the lower rate of long-term capital gains tax (20% with indexation) for those with a term longer than three years. Fourth, their closed-end structure avoids the kind of redemption surge that led to the winding up of six Franklin Templeton Mutual Fund schemes.
However, FMPs also come with three major disadvantages. First, their small size allows them to only hold a few debt papers. If one of these papers goes bad, their net asset values (NAVs) can take a major blow and the expected yield will not materialize. Second, if the papers are downgraded, investors cannot easily exit before the downgrade turns to default. Finally, FMPs do not offer the liquidity to withdraw money during an emergency.
FMPs, which invest predominantly in AAA paper, will not be a huge risk. Very few AAA debt papers with some prominent exceptions such as IL&FS and DHFL defaulted. FMPs also have a tax advantage over FDs," said Amol Joshi, founder, Plan Rupee Investment Services, a financial planning firm. “That said, I have never recommended any FMP to any client. Lack of liquidity is a major negative."
Investors should be cautious about FMPs as covid-19-driven disruptions can cause further defaults. Large segments of borrowers are under the Reserve Bank of India’s moratorium, but this pause on default recognition may not continue indefinitely. The small size of FMPs and their inability to hold more than a few papers magnifies this list.
Also, the portfolio of FMPs are not disclosed beforehand, only the indicative credit quality is mentioned. This is in contrast to open-ended debt funds, where you know what you are buying. Investors who want to reduce interest rate risk can look at the Bharat Bond funds as an alternative.
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