FIXED MATURITY PLANS

Mutual Funds

Beating fixed deposits by a huge margin

PERHAPS you have heard the Chinese curse that goes: “May you live in interesting times.” We are certainly doing that, what with the turbulence and volatility in the market. Gone are the days of slow and secular trends; they have now been replaced by sharp movements, accompanied by tremendous volatility. We in India and Asia swing between the coupling and de-coupling theories floated by experts to try and rationalise erratic and extreme market behaviour often led by forces beyond our control and boundaries. In such times it often pays for investors to dig a little beneath the surface to find products and investments that protect capital while seemingly offering higher comparative returns. One such product which is a direct clone of Bank Fixed Deposits (FDs) but offers much higher returns accompanied by much lower taxation is Fixed Maturity Plans (FMPs). They are also known as Fixed Interval Plans in some case.
    FMPs essentially are closeended debt oriented funds having a fixed maturity horizon. The primary objective of a FMP is to generate income while protecting the capital by investing in a portfolio consisting mainly of debt and money market securities. Thus, debt instruments like government bonds, corporates bonds and money markets instruments like treasury bills, certificates of deposits and commercial papers form part of FMPs portfolio. The maturity of the portfolio of a FMP coincides with the pre-specified tenure of the product. The tenure of FMPs can be of different maturities ranging from one month up to three years. To put it simply FMPs are like FDs which have a certain maturity period like one or two years and offer a certain indicative rate for the same.
    FMPs are similar to FDs in nature. As the maturity amount of a fixed deposit in a bank is “guaranteed”, similarly the returns or yields of FMPs are indicated when the FMP is launched though they are not guaranteed in any manner by the fund houses. The actual returns delivered by an FMP are generally in line with the returns or yield indicated at the time of investing. Conservative or riskaverse investors with low risk appetite, who predominantly invest in Bank FDs and other such riskfree investment products, should certainly invest in FMPs and earn better returns on their investments.
    FMPs are very popular with mutual fund investors,
especially with retail and high net worth investors due to their seemingly risk-free nature coupled with high posttax returns. Further, FMPs of different tenures right from one month up to three years are available in the market. Thus, individuals can select an FMP according to their investment horizon. It is as simple as investing in FDs. Just check out which FMPs are currently available in the market along with their tenures and returns indicated and invest in the same. There are no other hassles and it is much convenient for all investors.
    The biggest advantage of an FMP is that unlike a regular bond fund where returns are market related and hence uncertain, in FMPs, the returns are pretty much indicated at the time of investment. Thus investors are aware at which indicative yields their investments are locked in and therefore do not have to worry much about any volatility in returns. The actual returns are more or less close to the indicative yields or returns declared at the time of launch of the scheme. Further, FMPs also do not carry any tangible credit risk as they are generally invested in high quality debt and money-market instruments having good credit rating.
    It works in quite a simple fashion where fund managers ascertain at what rates they can invest the money for certain tenure. Once they have an indicative rate, they deduct the fund management expenses from the same and offer the balance to customers. It is worth noting that due to intense pressure amongst fund houses to sell their FMPs, the management expenses deducted by them are quite low thus offering high comparative returns to all investors.
    FMPs also assert superiority over bank fixed deposits with respect to taxation. The dividend distribution tax for FMPs in case of individuals is 14.16%. Thus, even though an individual may belong to the highest tax bracket, the distribution tax that is applicable in a FMP for that individual is only 14.16% as against over 33.99% (highest marginal tax rate) in case of FDs. Similarly, for corporates the dividend distribution tax for FMPs is 22.66% which is lower than maximum corporate tax rate, again at 33.99%. Hence FMPs are extremely tax-efficient for all investors and score tremendously against other competing products like FDs.
    Thus, FMPs deliver a superior combination of higher returns, tax efficiency and safety of capital. The tax attraction increases when the term of the FMP is one year and above. Longer term FMPs offer indexation benefits to investors, which is not available in case of FDs. Let’s consider an FD offering 8.00% and an FMP offering 8.00%. In case of FD an investor would have to pay tax at rate of 33.99%, assuming the investor falls in the highest tax bracket. Thus, the post tax returns would come to paltry 5.28%. While in case of FMPs, investors are subjected to long term capital gain tax at the rate of 10.33% without indexation benefit and 20.66% with indexation benefits. Thus, the post tax returns would be 7.17% without indexation benefits and 7.20% with single indexation benefit for a period of 1 year. Thus, FMPs deliver unbeatable tax efficiency.
    FMP returns are dependent upon the underlying market returns at the time of their launch. It has been observed that returns of FMPs peak around March every year and start declining from April to September. Last year many FMPs offered one year returns of over 10.50% in March thus delivering posttax returns of over 10% to investors. This year the trend is no different and FMP returns are already high at over 10% for 90 days and 9.50% for over 365 days as against FD rates of 5.50% and 6.75% respectively. It is a no brainer that FMPs are significantly superior to FDs and investors should strive to take maximum benefit of the same.
    Sameer Kamdar is Country Head, Mutual Funds, Mata Securities
Times of India Mumbai, 26th Feb 2008, Page 39

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