When it comes to investments, there are products which can potentially generate higher returns but are associated with relative higher risk — such as equity-oriented products — and products which are linked to fixed income instruments and are associated with relatively lesser risk. Both these products are good in their own ways, and you have to decide based on your investment goal.

If the two factors that you look for are lower risk and some reasonable returns, then fixed maturity plans (FMPs) are a good option for you. FMPs are close-ended debt mutual fund schemes where you get your money back with appreciation after a specific period. They are quite similar to your traditional investments such as fixed deposits wherein you deposit money for a fixed period and receive interest plus principal on the money deposited, at maturity. While in traditional investments the money is with the bank, in case of FMPs, the money is lent to corporates or government for a period similar to that of the maturity of the fund.

Save on tax

A key differentiating factor for FMPs is the lower tax rate. Being debt funds, FMPs attract long-term capital gain (LTCG) tax for investments made over three years. What this means is, if you invest in an FMP having a maturity of more than three years, you will have to pay LTCG tax on the return generated. As per the current tax laws, LTCG tax is 20 per cent post-indexation. Indexation benefit adjusts the costs for inflation, thus leading to lower taxable income.

To understand the concept better, let’s assume you had invested ₹1 lakh in an FMP in May 2015, when the cost inflation index was 254. The maturity is in July 2018, when the cost inflation index was 280. The cost of purchase as adjusted for inflation now would increase to ₹1.1 lakh, and the capital gain now calculated taking ₹1.1 lakh as the purchase price will be lesser.

Further, as fund managers invest in securities at the time of launch of the FMP for a period equal to the maturity of the scheme, the returns of these schemes are market-linked. FMPs are a good option for investors who wish to lock in their returns at the current market yields and aim to avoid taking a call on the change in interest-rate cycles. FMPs carry lower interest-rate risk as they invest in debt securities at the time of launch of the scheme and do not sell them during the tenure of the fund.

Before you invest

Though FMPs offer tax benefit and can help you lock in returns at the prevailing market yields, there are certain factors investors need to consider before selecting which FMP to invest in. The investment horizon of the investor is the first important factor to be taken into consideration while choosing an FMP. FMPs are issued by fund houses for short as well as long terms. You should select an FMP having a maturity period similar to your investment horizon as the money is locked in for the investment period.

The next important factor is the portfolio quality as FMPs carry credit risk. For instance, if you are risk-averse, you can look at FMPs which have higher credit quality — they invest in companies which are more creditworthy and financially stable. On the other hand, if you have a slightly higher risk appetite, you can consider FMPs that have higher yields — they invest in companies that have relatively lower credit rating. Lastly, although FMPs are listed on the stock exchange, they have limited liquidity. The investments are locked in until maturity and you need to be cognizant of that.

Generally, returns from traditional investments such as fixed deposits and interest rates move in line; however, currently there is a lag between the two because of lesser lending opportunities available with banks. Hence, it is an appropriate time to benefit from the rising yields that FMPs are able to capture.

 

The writer is Executive Directorand Chief Marketing Officer, SBI Mutual Fund.

Related Topics
comment COMMENT NOW