Whenever, we think of fixed returns, the first investment avenue that comes to our mind is bank fixed deposit (FD). We often tend to follow the traditional investment avenues as these are considered safe and tend to provide fixed returns. But Fixed Maturity Plans (FMPs) is another alternate investment avenue which should be considered before making an investment decision towards your debt portfolio.
What are Fixed Maturity Plans?
Fixed maturity plans are type of debt fund where the investment portfolio is closely aligned to the maturity of the scheme. AMCs tend to structure the scheme around pre-identified investments. Further, like close-ended schemes, they do not accept money post NFO (New Fund Offer). The characteristic of FMP is such that they are passively managed by the fund manager.
FMPs are somewhat different than a fixed deposit in a bank. FMPs are debt schemes, where the corpus is invested in fixed-income securities. Even though, FMPs may have an exposure to high quality debt securities, FMP’s returns are not ‘guaranteed’. Predominantly, because the fund house knows only the interest rate of the securities that the FMP will earn on its investments.
How do they work?
The basic objective of FMPs is to generate steady returns over a fixed tenure, thus shielding investors from interest rate fluctuations. FMPs achieve this by investing in a portfolio of debt securities [predominantly certificate of deposits (CDs) and commercial papers (CPs)] whose maturity or tenure matches with that of the scheme. These securities mature on or before the end of the FMP term.
For example, if the FMP is for 12 months, the fund manager will invest in instruments with a maturity of 12 months or less. Since FMPs are closed ended and investors cannot redeem units with the mutual fund during the FMP tenure, the fund manager need not sell any part of the portfolio (to provide for redemption) during this tenure thus locking the yield of the portfolio. This also mitigates the risk of loss on premature sale of securities and lowers the interest rate risk. However, the investors have the option to redeem the units of FMPs on the stock exchanges, where the FMPs are listed, and hence may impact the portfolio’s return to the extent of redemptions received. Also, the fund manager at his discretion may churn the portfolio of the FMP in order to get a better yield.
FMPs, however, are not allowed to provide 'indicative yields' to investors like in the case of FDs, where interest rates are pre-defined. However, in a rising interest rate environment (as is currently prevailing), FMPs will inherently capture this trend.
Where do they invest?
FMPs have exposure to high quality bonds (generally AAA/AA rated). As FMP being a debt fund, the portfolio is more tilted towards fixed income securities like certificate of deposits (CDs), commercial papers (CPs), Corporate Debt, floating rate instruments, pass through certificates (PTC), money market securities, government securities etc. The exposure across different debt instruments makes it more attractive and reduces the portfolio risk.
The FMP comes with different maturities like 1 month, 3 months, 6 months, 1 year, 3 years or even more. The different maturities provide an option to investors to choose an FMP as per their investment horizon.
We will be explaining the Tax Advantages of FMPs in detail in our next week article.
Mutual fund investments are subject to market risks, read all scheme related documents carefully.