What Are FMPS??: Fixed Maturity Plans (FMPS) Are Back in Vogue

Fixed maturity plans (FMPs) are back in vogue
What Are FMPs??
FMPs or Fixed Maturity Plans are Mutual Fund schemes with a fixed maturity date i.e., they
run for a fixed period of time. “This period could range from 15 days to as long as two
/three, five years or more. Like in an FD, when the period comes to an end, the scheme
matures, and your money is paid back to you. Generally, considered to be a safe
instrument, nonetheless, retail investors should exercise care before committing their funds,
given that returns on a bank fixed deposit are more or less guaranteed and returns on an
FMP are not.
Given this, it makes sense for investors to invest only in FMPs of mutual funds which have a
pedigree and reputation.
Why FMPs??
Interest Rates are going up...
The demand for money from corporates and banks is likely to go up in the days to come,
thus pushing up interest rates further. The short-term interest rates are nearing its peak.
This indicates an opportunity to lock in money with a one-to-three-year time frame. Returns
on short-term financial securities (which FMPs invest in) have already moved up and there
is still some scope for returns to go up more if there is dearth of liquidity in market due to
IPOs & FPOs and also measures taken by RBI to tame inflation.
Please find the yields for AA+ and AA Corporate Bonds over a period of 3 months to 3
years. As you can see the yields for 1Year AA+ and AA is close to 10% and for most of the
tenors of 1-3 years range it is in the range of 9.75%-10%. FMPs typically invest in these
securities and hence the yields of FMP’s have also headed northwards. It is easy then to
deduce the yield of a FMP which invests in any of these securities by reducing the expense
ratio from the yields of these papers (typically in the range of 0.50% to 0.60% approx.)
For E.g. a 13 Month FMP investing in 1 Year AA+ Corporate Bond would earn anywhere
between 9.40% - 9.30 % before Tax depending upon the expense ratio.
Tenor AA+ AA
3 Months 9.49% 9.67%
6 Months 9.68% 9.86%
1 Year 9.90% 10.07%
2 Year 9.73% 9.91%
3 Year 9.65% 9.86%
Source: Bloomberg
One is bound to forego 20-25 basis point uptick in returns if at all one goes wrong on timing
and hence you will be better off investing more than half of the money you allocated to FMP
now (i.e. JFM)
Please note that it was standard practice among mutual funds to give out indicative returns
on FMPs before investors invested. They managed to do this because an FMP which matures
in 370 days invests in financial securities maturing in the same time period. This gave
mutual funds a fair idea about the returns on offer.
Depending on the return the securities maturing in one year were giving, the FMP gave an
indicative yield to the mutual fund distributors. This practice is banned by the Securities and
Exchange Board of India (SEBI).
The tax benefit due to indexation...
What gives FMPs the edge is the greater tax efficiency they offer. In other words, on a tax-
adjusted basis, the return on an FMP is higher than that of a bank FD. The entire interest
earned on an FD is taxable, depending on the tax bracket you fall in. For those falling in the
30.9% highest tax bracket, the real return from a one-year fixed deposit paying an interest
of 7% is around 4.84%.
However, the return on an FMP is categorized as a capital gain. So, for a period of more
than one year, an FMP is taxable at the rate of 10% without indexation or 20% with
indexation, whichever is lower. For instance, an individual invests Rs 50,000 in an FMP. The
rate of inflation is 5% and the return on the FMP after 370 days is around 8%. This means
that the investor gets Rs 54,000 at maturity, which implies a gain of Rs 4,000.
This gain taxed at the rate of 10% would mean a tax payment of Rs 400 and a net gain of
Rs 3,600 which would imply a return of 7.2%. If we take indexation into account, the cost
after inflation goes up to Rs 52,500 (Rs 50,000 + 5% of Rs 50,000). So, the capital gain in
this case is Rs 1,500 (Rs 54,000 – Rs 52,500). And a 20% tax on this works out to Rs 300,
which is lower than the Rs 400 tax that needs to be paid without indexation. So, the net
gain is actually Rs 3,700 (Rs 4,000 – Rs 300), or 7.38% (Rs 3,700 expressed as a
percentage of Rs 50,000).

What Are FMPS??: Fixed Maturity Plans (FMPS) Are Back in Vogue

Uploaded by

Copyright:

Available Formats

What Are FMPS??: Fixed Maturity Plans (FMPS) Are Back in Vogue

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

What Are FMPS??: Fixed Maturity Plans (FMPS) Are Back in Vogue

Uploaded by

Copyright:

Available Formats

Fixed maturity plans (FMPs) are back in vogue

What Are FMPs??

Interest Rates are going up...

The tax benefit due to indexation...

You might also like