The FMP mess – Should you invest in a Fixed Maturity Plan?

If you have come across an FMP sales pitch, it almost always is that “it is as safe as a Bank FD”, yet, “it will give higher returns than an FD.” An easy lure for most investors since ‘safe returns’ is a primary criteria.

You don’t like that FMP word any more. Do you?

In 2016, I wrote how FD returns have reduced and fund houses are doing the best to offer an alternative to the ‘safe but higher return’  seeking population.

People did invest then. And the ghosts have come back to haunt. One of the FMPs launched then, HDFC Fixed Maturity Plan – 1148 Days – Feb 2016 is due for maturity. Unfortunately, it has exposure to the Zee group (almost 20% of the FMP investments), which is doubtful of recovery for now and the Zee group promoters have asked for time to pay up.

The fund house along with other lenders has complied to their request believing that it is in the investor’s best interests. And so, it asked its investors to make a choice – take the money on maturity with a cut for the bad investments OR rollover (delay the maturity) for a chance to recover the full money.

Unfortunately, that is not what the investor signed up for. Her idea of an FMP was a safe return product, which gave better return than an FD as also better taxation. Turns out she was wrong!

No good time than the current crisis to rebuild a fresh perspective on FMPs and ask if they should be a part of your portfolio?

What is an FMP or a Fixed Maturity Plan?

If you have invested in a Bank FD before, you know that it comes in for different tenures of 1 year, 3 year, 5 year, etc. 

Now, you have probably also heard of a debt mutual fund.

If, no then you should read about debt mutual funds here.

An FMP is sort of a hybrid of the two. It is a debt mutual fund but with a defined tenure or period like a Bank FD.

To take some examples of names of FMPs –

• HDFC Fixed Maturity Plan – 1148 Days – Feb 2016
• DSP BlackRock Fixed Maturity Plan – Series 155 – 12 months
• Birla Sun Life Fixed Term Plan – Series LQ – 368 days

So, an HDFC Fixed Maturity Plan – 1148 days – Feb 2016 means that it is a FMP that is going to start in Feb 2016 with a maturity of 1148 days or roughly 3.14 years.

Similarly, the Aditya Birla Sun Life FMP is for 368 days.

But is an FMP as good as a Bank FD?

Yes, that is the top question on your mind. Frankly, an FMP resembles a Bank FDbut only in the way it is structured. They come in several tenures too including 1 year, 3 years, sometimes longer.

Recently, 3 years+ tenures have become a norm and that is because of the long term capital gains implication. You get cost indexation benefit and hence pay lower tax.

Now, to list some of the differences between an FMP and a Bank FD:

1. Bank FDs offer guaranteed returns in the form of interest. There is no guarantee of returns in FMPs.
2. The principal amount that you invest in Bank FDs is also guaranteed by the government to the extent of Rs. 1 lakh. No such guarantee with FMPs.
3. FMPs have a daily price unlike FDs and are affected by changes in interest rates. FDs are a straight line.
4. If something goes wrong with one of the investment made by an FMP, it has to reflect in its value, which is adjusted (usually downwards) and affects you as an investor. With an FD, even while NPAs are the norms with banks, an FD continues to pay its promised interest and principal back.
5. But let’s look at another side too. FMPs are more transparent in terms of disclosures about where they invest the money, average maturity and credit quality of the portfolio, and other details. On transparency basis, Bank FDs are a black hole. But then who cares?

You would also find that with an FMP, the average portfolio is of a reasonably high credit quality that is AA / AAA. That means lower risk.

Does an FMP give you better returns than Bank FDs?

It could but that is not guaranteed. Most fund houses attempt to generate a higher return than a Bank FD, since that becomes a major selling point.

To generate higher returns, an FMP would have to invest in not so high credit quality instruments, thus taking on relatively higher risk.

Now if you see, a year ago, the 1 year Bank FDs were available for 6 to 7% interest rates. (Senior citizens get half to 1 % more.) The return generated by FMPs in the last one year has been in the range of 7% to 8%.

Returns do not look like a differentiator for FMPs.  

What about taxation?

With Bank FDs, you have to add the interest that you earn as a part of your income and it is taxed accordingly.

As you would know, debt mutual funds such, as FMPs, attract short term and long term capital gains tax. If you sell or redeem your debt mutual fund or FMP within 3 years, you will attract short term capital gains at the marginal rate of your income tax bracket. The same would be long term capital gains tax of 20% after indexation, if you sell or redeem after 3 years.

For High Net worth Individuals or corporates, using debt mutual funds turns out to be more tax-effective. By paying indexation based long term capital gains on debt funds instead of tax on FD interest, they are able to save a precious rupees.

Does the lock-in make sense?

If you look at comparative data between Liquid, Ultra short term funds and FMPs, the former turn out to be better.

As you would know, liquid funds and ultra short term funds are open ended, that is, you can invest or redeem any time you want. There is no lock in.

Liquid and UST funds also hold an equally good credit quality (investment grade AA / AAA) in their portfolios.

As for returns, they have in some cases delivered a better return than FMPs.

So, getting into a lock-in with an FMP has no additional benefits.

What should one do – invest or not?

If we were to summarise the key aspects of an FMP, it would be:

Liquidity – Lock-ins with windows of redemption, but with exit loads;

Safety – Depends upon the kind of instruments the fund invests in; Typically is investment grade quality. Current experience has started to point otherwise.

Returns –  No significant difference in returns with reference to Bank FDs or Liquid / Short term funds. Remember, every bit of extra return comes at a cost, usually lower quality of portfolio (higher risk).

Taxation – Can be tax effective on an indexation basis for HNIs and Corporates. For a retail investor in the lowest tax bracket, this too ceases to be a differentiator.

As a retail investor, you are better off ignoring the marketing noise. Avoid FMPs. Based on your time horizon and risk appetite, choose a Bank FD or a liquid fund or an ultra short term fund. You will sleep well.

Between you and me: Have you been affected by the recent FMP crisis? Or you are simply a Bank FD fan? How do you go about making your fixed income / debt investments? Do share in the comments.