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A primer on Fixed Maturity Plans

ICICI Securities 05 Sep 2021 0 COMMENT

If you happen to have some surplus funds which you don’t need for a specific period, but you don’t want to take the risk of investing this money in the stock market, you can very well put this money in a Fixed Maturity Plan or FMP. These plans are designed to give you an indicative return that you are aware of at the time of investment. In this article, we will walk through a primer for FMPs.

Let’s begin with the basics of FMPs.

Fixed Maturity Plans, or FMPs are close-ended debt funds which have a fixed maturity period. They are not up for subscription continuously. You can invest in one only when the respective Mutual Fund asset management company puts out an NFO, a New Fund Offer.

FMPs invest in debt and money market instruments like corporate bonds, treasury bills, government securities, certificate of deposits amongst many other instruments.

The key principle behind FMPs is that they invest in debt securities whose duration is aligned with the tenure of the FMP. As an example, a one-year FMP will invest in debt instruments which mature in one year or just before one year. What this does is that it minimizes the interest rate risk on the investments. But what this means to you? These plans will hold the securities until maturity and earn a fixed return known to fund managers at the time of investment.

One of the defining characteristics of FMPs is that once you have invested your money through an NFO, your investment is locked-in till maturity. This is done to generate fixed returns from the underlying securities. So, if you are looking for an early withdrawal, these funds may not be suitable for you.

Let’s now talk about some advantages of investing in FMPs.

What makes FMPs different from other debt funds is that the fund manager of an FMP does not engage in frequent buying and selling of debt securities, a buy and hold approach is followed. This helps in keeping the expense ratio of FMPs at a lower level as compared to other debt funds.

As any fluctuations in the stock market have a relatively lower impact on debt securities, FMPs inherently happen to be more stable as funds will not sell the securities before maturity and, therefore, there is no price fluctuation risk.

On top of these, FMPs have a tax advantage over Bank Fixed Deposits or Bank FDs.  FMPs have a similar tax rate as FDs if held for less than three years.

When you hold your FMP for 3 or more years and then redeem it for gains, your gains are then termed as long-term capital gains and eligible for indexation benefits. FMP’s long term capital gains are taxed at 20% and offer additional indexation benefits if invested for more than three years. These tax rates could be lower than bank FD if you fall into a higher tax slab.

Now indexation can be defined as an adjustment in the price at which you purchased the asset in order to reflect the impact of inflation on it and you’re taxed on the inflation-adjusted capital gains rather than the original capital gains.

FMPs also offer double indexation and it goes one step ahead than this. Double indexation is applicable when the investment is made at the end of a financial year, held through the next, and sold at the start of the third financial year. As the inflation benefit is calculated based on the purchased year and the selling year, you will get double benefit even if you invested in a financial year for a day. For example, you have invested Rs. 100 in an FMP on 31 Mar 2018 and sold the FMP on 1 Apr 2021. As the investment period is more than three years, you are eligible for indexation benefits. As you have invested on the last day of the financial year 2017-18, you will get the inflation benefit of that year also. This means you get the benefit of four financial years, i.e., FY 17-18, 18-19, 19-20 and 20-21.  Investment timing is crucial to get this benefit.

Let’s now come to the risk associated with investing in FMPs

 Unlike FDs, results are not guaranteed, they are indicative in nature. All that means is that there is a chance of the actual returns being either higher or lower than the returns which were indicated during the NFO.

Secondly, the stringent lock-in period reduces the liquidity of FMPs as you cannot redeem your investment before the maturity period of the FMP.

To conclude, let’s summarize everything we discussed:

  1. FMPs have a fixed lock-in period and you can only invest in them when the fund puts out a subscription offer, the NFO.
  2. FMPs invest in debt securities whose duration is aligned with the tenure of the FMP. This helps to generate fixed returns. which is why FMPs happen to be more stable.
  3. FMPs are highly illiquid as investors cannot redeem their money before the maturity period of the FMP.
  4. Investing in FMPs for 3 or more years helps you in saving taxes on long-term capital gains due to indexation and double indexation benefits.

Disclaimer:

ICICI Securities Ltd.( I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Centre, H. T. Parekh Marg, Churchgate, Mumbai - 400020, India, Tel No : 022 - 2288 2460, 022 - 2288 2470. AMFI Regn. No.: ARN-0845. We are distributors for Mutual funds. Mutual Fund Investments are subject to market risks, read all scheme related documents carefully. Please note, Mutual Fund and Fixed Deposit related services are not Exchange traded products and I-Sec is just acting as distributor to solicit these products. All disputes with respect to the distribution activity, would not have access to Exchange investor redressal forum or Arbitration mechanism.  The contents herein above shall not be considered as an invitation or persuasion to trade or invest.  I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. The contents herein mentioned are solely for informational and educational purpose.