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How to Select Mutual Fund Fixed Maturity Plans (FMP)

A mutual fund Fixed Maturity Plan (FMP) is a closed-ended debt mutual fund. A discussion on how and when to choose FMPs.

A closed-ended mutual fund is one in which no purchase or redemption can be made after the new fund offer (NFO) period. The scheme has a fixed maturity date and unitholder can redeem from the AMC only after that date. These schemes are listed on the exchange and in principle can be bought and sold with a Demat account in the secondary market. However, this is unlikely and most closed-ended mutual funds do not have any liquidity.

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What is a Fixed Maturity Plan?

A fixed maturity plan is a one such closed-ended mutual fund which invested in fixed income securities - bonds offered by banks, PSUs, corporates, GOI, cash and even debt arbitrage. There is a wide spectrum of FMPs and only those that understand where the fund will invest should choose them or any mutual fund for that matter.

Although the NAV of the FMP will be marked-to-market - the value of bonds will fluctuate with supply and demand forces driven by interest rate and credit rating changes - the fund manager will typically not actively trade these bonds.  She would buy the bonds and hold them until maturity.

Therefore, even if the NAV fluctuates (+ve or -ve), it will recover* when the bonds held in the portfolio mature. A dramatic example of this in an FMP can be found here: Debt Mutual Funds: NAV Recovery after Credit Rating Downgrade

* If the bond issuer does not default.

Therefore, as long as the fund manager has done her research well and chosen credit-worthy bonds, the risk associated with an FMP is lower than an open-ended debt mutual fund.

If I can afford to lock my money for the next 3-4 years (often only a gamble as future money needs are uncertain), then I can afford to choose an FMP that invests in PSU or corporate bonds that mature over that time period.

If there are no defaults (not rare!), then I can expect to earn the indicative yield mentioned in the scheme information document. Which us to:

Who Should Invest in FMPs?

Only an investor who is not lazy enough to download the scheme information document (SID) from the AMC website and understand the scheme

  • the scheme objective
  • intended asset allocation
  • investment strategy
  • risks
  • indicate yield

And most investors are lazy. They want pre-packaged, sorry make that pre-digested information. Good luck finding that for an FMP NFO.

An FMP is less liquid than a fixed deposit. The money will be practically locked in until maturity. So tread with caution. FMPs are not suitable for most retail investors who have only a small investible surplus to spare.

In certain situations, an FMP makes sense. For example, say you have just become a parent or just got married and received a gift of say, Rs. 5000 or Rs. 10,000. This is not money that you going to depend on in future (if). Then you can put that in FMPs and keep rotating them IF that kind of asset allocation would be suitable for your future needs. Just an example. Don't read too much into it.

Tax treatment of FMPs

Any mutual fund which holds less than 65% of Indian stocks on average over a year is a non-equity mutual fund as far as the income tax department is concerned. So is FMP.

The capital gains arising from units purchased less than or equal to 3 years ago will be added to income and taxed as per slab. Gains from units older than 3 years is taxed at a flat 20% (+cess) with indexed capital gain.

During periods of high-cost inflation, the gains from an FMP could be tax-free. By the same token, during periods of low inflation, the gains would be considerably less, even before tax. And after-tax not very different from FDs.

Where do FMPs invest?

Anywhere and everywhere in the fixed income universe! To find out, go to

https://www.valueresearchonline.com/funds/fundselector/

and use the following settings: Exclude commission-based (regular) plans, open-ended plans (yes, there are open-ended  FMPs too!! Also known as interval funds. More on this in a separate post)

mutual-fund-fixed-maturity-plans-fmp-1

You would then get a list of ongoing FMPs. You cannot invest in any of these! 

Do not waste time over analysing the returns they have made. Each FMP is different and so will be the returns be. Also, current bond yields would be very different. So unless you check the SID, you cannot get an approximate idea of the return expected from an FMP.

This exercise is to understand different types of FMPs and how returns can vary. Remember: When it comes to debt funds, higher the returns, lower the credit quality!

Now click on the portfolio tab in the above page.

mutual-fund-fixed-maturity-plans-fmp-2

Click on average (portfolio) maturity column - to arrange in ascending order. Notice that there are FMPs which are basically liquid funds with an average maturity of 0.003 Years (~ 1 day!!) to 6.41 years (long-term gilt funds + cash).

Click on average credit quality to arrange in ascending order. Cash or Gilt (GOI) to AAA to A.

Click on bond fund style and hover over the square to understand its placement.

You can download this data as a spreadsheet and play around with it too.

The tenure of the FMP need not match with the average portfolio maturity. The latter can be much less (not more). So within the holding period, the fund manager can use the gains from a matured bond and buy more that mature before the closing date of the fund.

There are no FMPs below (or equal to) 3Y today. Just in case, be sure to select one that matures in 1096 days or more. Not 1095 days (365 x 3) - then you will have to pay tax as per slab!

So once you are comfortable, you can decide what kind of FMP you would like to invest in.

Over to the Scheme Information Document

Here are some extracts from the (randomly chosen)SID of UTI FTIF Series XXV-XII _1198 days.

Reading suggestion from the table of contents.

mutual-fund-fixed-maturity-plans-fmp-7

Fundamental attributes

mutual-fund-fixed-maturity-plans-fmp-6

How to Estimate FMP Returns

If you knew where the FMP would be investing, it is easy to make a conservative estimate of returns. The following two snapshots from the SID are crucial.

mutual-fund-fixed-maturity-plans-fmp-4

mutual-fund-fixed-maturity-plans-fmp-3

The scheme can invest in both Bank, PSU and corporate NCDs of AAA (80%) and AA quality. So I see that 1Y corporate AAA bond have a yield (IRR) of ~ 7.2%.

Therefore, I can assume that the FMP would offer a return of about 7% conservatively. Whether this return is good enough (compared to an FD) or if should consider another FMP etc. are questions that I need to ask and answer from a personal perspective (Speaking of which, I value liquidity of a portfolio above all else and will not use FMPs).

In conclusion, FMPs can be used intelligently by an informed user who understands the pros and cons of the instrument.

What should investors new to debt funds do?

Stay away from any debt fund with an average maturity profile greater than one year.

Read more:

Debt Mutual Funds: Risk vs. Reward

How to choose debt mutual funds with no credit risk and low volatility

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