What are Fixed Maturity Plans & How they Work?
Fixed Maturity Plans (FMPs) are debt-oriented close ended mutual fund schemeshaving a defined maturity profile. These schemes invest in debt or money market instruments maturing on or before their maturity date. For example, if an FMP has a tenure of 3 years, then the fund manager will invest in securities with a maturity of 3 years, falling not later than the maturity date of that FMP. These securities can be certificates of deposits, commercial papers,treasury bills, corporate bonds, government securities, state development loans, etc.
FMPs are closed-ended, which means investors are not freely allowed to enter or exit the fund at any time. FMPs open for subscription only during a specified period at the time of the launch of the scheme by the asset management company (AMC).However, these FMPs are listed on a recognized exchange, where investors can buy or sell the units of the scheme.
How do FMPs work?
FMPs intend to minimize the interest rate risk. When you are invested in debt securities, any rise in interest rates may lead to a fall in the value or price of the securities.However, since FMPs are closed-ended, the investments are generally held till maturity, and hence yields are locked at the time of investments, leading to aversion and insulation of portfolio yields from the changes in the interest rates during the tenure of scheme.
Things to note about an FMP:
No guaranteed return – FMPs do not offer guaranteed returns, unlike traditional term deposits; however, they lockin the prevailing yield of securities at the time of investment.
Credit-quality of the bonds- The intended rating allocation of FMPs is pre-defined for each FMP and is given in their scheme documents. While some FMPs invest only in higher credit rating bonds or G-Secs, some FMPs take exposure in lower-rated securities, which may generate relatively higher yields given the additional risk they bear. You should invest in FMPs aligning with your objective, investment horizon, and risk appetite.
Tax implications- If you remain invested in the FMP having tenure of 36 monthsand above, you can enjoy thelong term capital gain (LTCG) benefit along with indexation benefit wherein you pay tax only on inflation-adjusted capital gains. This may be beneficial and help you save considerable tax.
Liquidity Risk- FMPs are close-ended in nature, and any future trade can happen only on the exchange where they are listed. However, trading in the units of FMPs is negligible, making them practically illiquid. As an investor, you should ensure your investment horizon aligns with the tenure of FMP, since in the later stages, the only way you can opt-out of an FMP is to find a buyer for the units you are holding.
FMPs can be a useful tool for investorslooking to lockin their investments for a specified period to achieve their various short-term or long-term goals in line with the maturity profile of the invested FMP and are looking for some predictability in the returns. They make for a relatively stable investment option when compared to other open-ended debt funds and aim to bring in some diversity in your
debt mutual funds’ portfolio.