Make the most of fixed maturity plans

Following measures taken by the Reserve Bank of India to tighten liquidity, short-term rates have spiked in recent weeks.

This lends an attractive opportunity for investors in the debt market. Most fund houses have launched new fund offers (NFO) of fixed maturity plan (FMP) debt funds to lock into higher rates.

FMPs are close-ended mutual funds and you can only invest in them during the new fund offer (NFO). The funds, with an investment horizon of around one year, invest mostly in short-term debt instruments such as certificate of deposits (CD) from banks, and commercial paper (CP) issued by companies.

Currently one-year CDs offer close to 9.9 per cent and CPs offer around 10.8 per cent. The longer tenure funds invest in non-convertible debentures issued by companies. As FMPs invest in debt instruments that have the same maturity as that of the fund, they are free from interest rate risk. Given the sharp depreciation in the rupee, the RBI will not be in a hurry to reverse its measures. Hence the short-term rates will continue to remain higher.

Thus, shorter tenure funds, which are less risky, can offer anywhere between 9.8 and 10.4 per cent, depending on their portfolio. Bank deposits of similar tenure offer 9 to 9.5 per cent currently.

Aside from the attractive yield, for investors in the higher tax bracket, FMPs also deliver a better post-tax return than bank deposits.

In case of FDs, the interest is clubbed with income and is taxed as per the specified slab rates.

Fund houses normally issue FMPs that are slightly more than a year so investors can enjoy the benefit of lower long-term capital gains tax.

The tax rate applicable is 10 per cent without indexation or 20 per cent with indexation for inflation.

In case of longer duration FMPs, the returns may be lower in the range of 9.5 per cent, close to what most banks are offering.

However, post tax returns will still be better than bank deposits. Investors looking at longer duration funds should be aware of the credit risk these funds carry.

Remember bank deposits have minimal risk, and are insured up to Rs 1 lakh. But FMPs carry credit risk, as there is a possibility of default by the debt issuing company.

As these funds are locked till maturity, liquidity may become an issue beyond two years. Also, in spite of FMPs listed on the stock exchange, the liquidity is very poor. Credit rating agencies rate debt instruments based on the financial health of companies issuing such instruments.

Keeping the risk minimal we have selected funds that will invest in AAA or above rated paper, with an investment horizon of up to two years.

BNP Paribas Fixed Term Fund - Series 26 C

This fund will invest close to 95-100 per cent in A1 rated CDs. The fund matures in 367 days, and hence will give investors tax benefit on indexation.

As fund houses have started to take note of the increasing credit risk, they, upfront, declare sectors they will not invest in.

This fund will not invest in instruments issued by companies in the real estate, gems and jewellery sectors, micro finance institutions and airlines.

Avoiding exposure to these ailing sectors is comforting. Also, since the entire amount will be invested in CDs, the risk on this fund is the lowest. The fund closes on August 13.

Religare Invesco FMP Series XIX Plan F

This fund has a duration of 370 days and will invest in A1 rated instruments. Close to 55-60 per cent of the portfolio will be towards CDs and 35-40 per cent in CPs. Since returns on CPs are almost 1 per cent more than CDs, this fund may deliver higher returns. It will not invest in debt securities issued by companies in real estate and gems and jewellery. The fund closes on August 13. Investors with an investment horizon up to two years can consider Reliance Fixed Horizon Fund - XXIV Series 6 , open till August 21. The fund will mature in 628 days and invest 65-70 per cent in AAA rated and 30-35 per cent in AA rated non-convertible debentures. For investors in the higher tax bracket, post tax returns will still be more attractive than bank deposits. The scheme will not invest in real estate and airline sector.

COMMENT NOW