Understanding Fixed Maturity Plans

Fixed Maturity Plans (FMPs) are a common form of debt investment offered by mutual funds. They are tax-efficient and normally offer favorable returns. FMPs conceptually are more complex than other common debt investments such as Fixed Deposits (FDs) or liquid funds.

The Structure of an Fixed Maturity Plan (FMP)
FMPs are closed-ended debt schemes with a predetermined fixed maturity date before which investors can not withdraw their investments. All FMPs are exchange-listed, so investors can sell their units in the exchange and the mutual fund does not provide redemption facility before the maturity date. As trading of units of FMPs in the Exchanges is currently limited, it may cause difficulties for early exit. Only investors who are comfortable locking in their investment until maturity may opt for them.

Unlike FDs, FMPs do not offer a guaranteed rate of return. Depending upon the tenure of FMP, the Fund Manager invests in a combination of debt instruments of similar maturity. For instance, if the FMP is for a period of one year, then the investments are made in instruments of up to one year maturity so that the investments mature on or before the maturity date of the FMP. By doing this, the Fund Manager attempts to protect the yield of the portfolio and the investor can reasonably assess the likely income from the FMP at maturity based on the monthly disclosures of investment by the Scheme.

FMPs are tax-efficient; they are subject to capital gains tax or dividend distribution tax. For instance, an investor in an FMP with a tenure of over a year who opts to take gains as capital appreciation will attract a tax rate of 10% or 20% (depending on whether or not indexation is applicable). As against this, a FD of similar tenure might be taxed at 30%. FMPs of longer term maturities spanning over more than one financial year also offer better tax efficiency through double indexation.

As FMPs are passively managed funds, the portfolio turnover will be low resulting in lower transaction costs which enhances the returns for the investor. FMPs may have certain restrictions imposed in their portfolio construction based on offer terms. for instance, it might only invest in securities with an AAA credit rating or may not invest in debt issued by borrowers from a certain sector. Some FMPs include equity exposure in the form of convertible debentures.

FMPs, though they offer potential to earn better returns than Fixed Deposits are exposed to two types of risk:
1. Liquidity risk
2. Credit risk

Liquidity Risk
An FMP only invests in securities on a hold-to-maturity basis; once bought, each security is normally held until it matures. The secondary markets for debt securities is shallow at times. If for any foreseen reason a FMP is forced to sell a security during these times, it may leave limited options for such sale. The risk is called Liquidity Risk.

Credit Risk
The return offered by an FMP is entirely determined by the yields on the securities it has invested in. These yields reflects inter-alia in the credit risk of the borrowers - the riskier a borrower, the higher the yield of the borrowers offer their debt.
Investment in any debt contains an inherent risk of the borrower delaying or defaulting their obligations to pay the interest or redeem the debt on the due date. This risk is known as credit risk.

Summing up
Fixed Maturity plans are closed-ended debt schemes which are highly tax-efficient and normally offer favourable returns. However they offer no guaranteed return (unlike fixed deposits) and have limited liquidity options. FMPs can be an excellent investment for investors who clearly understand the risks associated with them.