Defending well can be a winning strategy too. A bunch of fixed maturity plans (close-ended income scheme), open now, are combining relatively-high interest rate and low credit risk by focusing on government securities. With this approach, they minimise the credit risk in the portfolio while the current level of G-Sec yields being significantly up from the pandemic levels, provide a potentially good entry point. Additionally, FMPs as an investment avenue offer better post-tax returns than fixed deposits, if held for more than three years. If your time horizon matches with the FMP tenure and you are okay with the lock-in, this may the right time to go for them.
An FMP is a fixed tenure mutual fund scheme that invests its corpus in debt instruments maturing in line with the tenure (declared at the outset) of the scheme. FMPs lock into interest rates because they are held-to-maturity instruments and offer high predictability of return. They can neither tweak their duration nor change the underlying instruments to add higher-coupon earning papers if those come up post FMP launch.
FMPs score over similar open-ended products such as target maturity funds, because the close-ended structure while limiting liquidity, also forces goal-oriented investors to stay put till the fund matures and hence protects them from interest rate risk.
While FMPs have had a chequered past due to some reasons such as taking exposure to low-quality papers, plans that focus almost exclusively on G-Secs/treasury bills, including State government securities, virtually nullify such risks given the high-quality and sovereign nature of portfolio constituents. G-Sec yields of 1-5 year segment and 1-3 year segment in the last six months have risen by 156-186 basis points and 220-plus basis points, almost in step with corporate yields. So, getting in now is a lucrative option given that rates are ruling high.
As per the intended portfolio allocation guidance in respective scheme information documents, ABSL FTP TU (1,789 days), HDFC FMP Series 46 (1,158 days) and SBI FMP Series 67 (1,467 days) would invest 95-100 per cent of net assets in government securities. These FMPs close for subscription between July 25 and 27.
With the tenure of these FMPs ranging from three to five years, indicative yield data for similar tenures of actual Central government and State government securities from Clearing Corporation of India shows 7-8 per cent yield to maturity (YTM). From a cost perspective, recent G-Sec oriented FMPs have total expense ratio of 14-25 basis points (regular) and 4-12 basis points (direct). All this gives a fair idea of expected returns.
FMPs with a tenure of more than three years provide the benefit of indexation — investors are allowed to adjust against inflation. These gains are taxed at 20 per cent after indexation. With retail price rise at 7 per cent level, indexation can come very handy and push down tax liability. In case of fixed deposits, entire interest is added to taxpayer income and is taxed as per slab rates. Essentially this means if you are in higher tax slabs, your post-tax return from FMPs will be higher than the return from bank FDs at the same rate of return.
To be fair, target maturity funds too have the tax edge thanks to the eligibility for indexation benefit. But their open-ended structure can expose them to the vagaries of intermittent inflows and outflows.
While government-securities focused FMPs are a low-risk option for those whose investment tenure matches with the specific product, there lies a low possibility of yields to go even higher. If that happens, previously-issued FMPs can't take advantage of them.
But if interest rates in the economy rise after you invest in an open-end debt fund, you may end up taking a capital loss because of the fall in bond prices. FMPs smartly sidestep this risk by exactly matching the maturity date of the bonds they hold with the scheme’s maturity date.
While global, especially US, consumer price inflation has remained uncomfortably high so far, inflation expectations have somewhat come off from peaks. So, on the whole, locking in at prevailing yields appears a sensible move.