Use FMPs to tide over interest rate volatility

Longer duration fixed maturity plans can yield annualised return of up to 7.7%

In the current uncertain interest rate scenario, investment advisors are suggesting fixed maturity plans (FMPs) to investors looking at debt funds. The pitch: Interest rates could go up from here, so lock-in your investment. Also, if an investor puts in money in March 2018 and the FMP matures after 37 months, he will get the indexation benefit for four financial years.

While FMPs do make sense in the current interest rate environment, they suit those who don’t want volatility in their investments and don’t mind locking in their funds for slightly over three years. “If an investor fine with volatility, then they can look at shortterm debt funds that follow an accrual strategy and have an average portfolio maturity between two and three years,” says Hemant Rustagi, chief executive officer, Wiseinvest Advisors. He feels open-end short-term debt funds can give marginally better returns.

Fund houses don’t reveal the expected returns of FMPs upfront. Investment advisors say they would give returns in the range of 7.7-7.8 per cent annually if the individual makes direct investment, and around 7.4

7.5 per cent annually if he invests through an agent. Investors can expect similar returns or up to 50 basis points higher return in short-term debt funds.

FMPs are closed-end debt schemes that invest in a variety of papers and hold these until maturity. As the holdings are not traded, FMPs don’t carry any interest rate risk. They carry credit risk, that is, the papers they have invested in could face downgrades or default. Most mutual fund houses provide an indicative portfolio to investors. Go with the fund house that’s investing in AAA-rated papers, even if the returns from these are slightly lower. While FMPs make sense for the longer duration, financial planners say investors should look at liquid funds for shorter tenures.

It’s true that if you invest in a longterm FMP in the month of March, you will get indexation benefit for four years. Typically, such FMPs are for 37-40 months. Indexation brings down the tax burden substantially. But, according to certified financial planner Arnav Pandya: “The indexation benefit of an additional year will not make a huge impact towards increasing returns. So, don’t fall for that part of the sales pitch.”

For investors who can stomach volatility, there are options. For those with an investment horizon of up to three years, short-term debt funds are an option. Pandya suggests that investors with a horizon of three-four years should look at dynamic bond funds. “They took a hit recently, but the fund managers have made the required changes,” Pandya says. To tide over the current volatility, an investor should ideally get into liquid or ultra-shortterm funds. Once there’s clarity on interest rates, investors can invest accordingly. But moving in and out of schemes means paying short-term capital gains tax. Instead, they can look at dynamic bond funds where the fund manager changes the portfolio actively based on interest-rate movement and other factors. If you don’t need the money for four-five years, Rustagi suggests opting for equity savings schemes. These are hybrid funds that invest 35-40 per cent in equities and the remaining in debt and arbitrage. They are, however, taxed as equity funds.