Fixed maturity plans (FMPs) are a type of debt mutual fund that invest in fixed income securities such as bonds, certificates of deposit, commercial papers, etc. They have a fixed maturity date, which means they lock in your money for a specified period of time, ranging from a few months to a few years. In case of redemption prior to maturity date, the investor needs to find a buyer in secondary market to sell the units. FMPs are suitable for investors who want to earn a steady and predictable return, without taking much risk.
Gain a thorough understanding of Fixed Maturity Plans (FMPs) by exploring our comprehensive guide. Discover key aspects such as their characteristics, benefits, drawbacks, tax implications, and suitability for various investors. Explore how FMPs can potentially align with your investment objectives.
What are Fixed Maturity Plans (FMPs)?
A Fixed Maturity Plan (FMP) is a type of mutual fund that invests primarily in debt securities with a fixed maturity date. The FMP's own maturity date is aligned with the maturity dates of the underlying debt instruments. FMPs typically have a tenure ranging from a few months to several years.
These securities are typically issued by various entities, including government and private institutions, seeking capital for business expansion or operational needs. The duration of an FMP can vary from as short as one month to as long as five years, aligning with the maturity period of the underlying debt securities. For example, a 3-year FMP will typically invest in debt instruments with a maturity of three years, providing a shield against market volatility.
Unlike some other debt funds, FMP fund managers employ a buy-and-hold strategy, refraining from frequent trading of debt securities. This approach helps maintain a lower expense ratio for FMPs compared to other debt funds, as there is less turnover of securities within the fund's portfolio.
How do FMPs work?
FMPs aim to reduce interest rate risk. When investing in debt securities, an increase in interest rates can cause the value or price of the securities to decline. However, because FMPs are closed-ended, investments are typically held until maturity. Therefore, yields are fixed at the time of investment, shielding the portfolio from fluctuations in interest rates throughout the scheme's tenure and ensuring consistent returns.
What are features of fixed maturity plans?
Listed below are some features of fixed maturity plans:
- Fixed duration of investment: FMPs feature a predetermined maturity period, locking in investors' funds from the time of New Fund Offer (NFO) subscription until maturity. Typically extending beyond 3 years, the maturity period commences from the allocation of units, enabling investors to leverage indexation benefits.
- Limited subscription window: As close-ended funds, FMPs restrict investment opportunities to the NFO phase. Once this period concludes, the fund ceases to accept additional investments, allowing investors to redeem units only after the fund matures.
- Reduced sensitivity to interest rate changes: Due to a significant portion of investments held until maturity, FMPs exhibit minimal sensitivity to interest rate fluctuations. By securing interest rates for extended periods, FMPs offer investors stability amid declining interest rate scenarios.
- Lower exposure to credit risks: FMPs predominantly allocate funds to high-quality debt instruments and money market securities, mitigating potential credit risks associated with lower-quality assets.
- Tax advantages through indexation: With many FMPs boasting maturity periods exceeding 3 years, they qualify for long-term capital gains tax treatment coupled with indexation benefits. Indexation, factoring in inflation, reduces investors' overall tax liabilities, enhancing the attractiveness of FMP investments.
Advantages of fixed maturity plans
Benefits of investing in Fixed Maturity Plans (FMPs)
- Lower risk: FMPs primarily invest in debt securities, which are generally considered less risky than equities.
- Stability: Debt instruments are less volatile than stocks, offering a degree of stability, especially during market downturns.
How is FMP different from other debt funds?
Below pointers show how FMP is different from debt funds:
- FMPs have a fixed tenure, while other debt funds are open-ended and can be redeemed anytime.
- FMPs have a low interest rate risk, as they hold the securities till maturity, while other debt funds are subject to market fluctuations.
- FMPs have a predictable return, as they disclose the portfolio and yield at the time of launch, while other debt funds do not.
Who should invest in FMPs?
FMPs are ideal for investors who have a low risk appetite, a fixed investment horizon, and a specific financial goal. They can also help in tax planning.
Limitations of a fixed maturity plan
Limitations of Fixed Maturity Plans (FMPs):
- Lower potential returns: Compared to equity investments, FMPs may offer lower potential returns due to their fixed nature.
- Limited liquidity: FMPs typically have a lock-in period, restricting early withdrawals and potentially impacting your access to funds.
Taxation on fixed maturity plans
Here are some limitations of FMPs:
- Short-term capital gains tax, if the FMP is held for less than three years, at the applicable slab rate.
- Long-term capital gains tax, if the FMP is held for more than three years, at 20% with indexation benefit.
Dividend income on mutual funds are taxed at respective tax slab rates.
Where do fixed maturity plans invest their corpus?
FMPs invest their corpus in fixed income securities such as corporate bonds, government securities, certificates of deposit, commercial papers, treasury bills, etc. that match their maturity date.
Would FMPs also classify as a debt fund category?
Yes, FMPs are a type of debt fund category, as they invest in fixed income securities. They are classified as low duration, short duration, or medium duration funds.
Differences between FMPs and FDs
Here are a few differences between FMPs and FDs:
- FMPs are mutual funds, while FDs are bank deposits. They are regulated by different authorities and have different tax implications. FMPs are regulated by the Securities and Exchange Board of India (SEBI), while FDs are regulated by the Reserve Bank of India (RBI). FMPs are taxed as capital gains, while FDs are taxed as income.
- FMPs generally offer a higher return than FDs, as they invest in higher yielding securities, while FDs offer a fixed and lower interest rate. For example, a 3-year FMP may offer a yield of 7.5%, while a 3-year FD may offer an interest rate of 6%. However, the return of FMPs is not guaranteed, as it depends on the performance of the underlying securities.
- FMPs have a higher credit risk than FDs, as they invest in corporate bonds and other securities that may default, while FDs are backed by the financial institute proving the FD. For example, an FMP may invest in an AA rated bond that may default due to financial distress, while a Bank FD is insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC) up to Rs. 5 lakh per depositor per bank.
- FMPs have a lower inflation risk than FDs, as they have a higher post-tax return, while FDs may lose value due to inflation. For example, a 3-year FMP may have a post-tax return of 6.4%, assuming a 20% tax rate with indexation benefit, while a 3-year FD may have a post-tax return of 4.8%, assuming a 30% tax rate. However, the inflation-adjusted return of FMPs may vary depending on the inflation rate and the indexation factor.
Here's a table summarising the differences between Fixed Maturity Plans (FMPs) and Fixed Deposits (FDs):
Criteria |
Fixed Maturity Plans (FMPs) |
Fixed Deposits (FDs) |
Type |
Mutual funds |
Bank deposits |
Regulatory Authority |
Securities and Exchange Board of India (SEBI) |
Reserve Bank of India (RBI) |
Taxation |
Taxed as capital gains |
Taxed as income |
Returns |
Generally higher, but not guaranteed (e.g., 7.5% for 3 years) |
Fixed and lower (e.g., 6% for 3 years) |
Risk |
Higher credit risk (invest in corporate bonds) |
Lower credit risk (backed by the financial institute) |
Insurance |
Not insured |
Insured up to Rs. 5 lakh by DICGC |
Inflation Risk |
Lower (higher post-tax return, e.g., 6.4% post-tax) |
Higher (may lose value due to inflation, e.g., 4.8% post-tax) |
Guarantee |
No guarantee on returns |
Guaranteed returns |
Who should consider such a plan?
Fixed Maturity Plans are well-suited for investors with a low risk tolerance. They offer relatively low volatility, making them less susceptible to stock market fluctuations. The fixed return nature of FMPs allows for better financial planning, as investors can accurately estimate their potential earnings. FMPs can be used as a core investment for risk-averse individuals or as a diversifying tool within a broader investment portfolio.
When should you choose FMPs?
FMPs are particularly well-suited for investors who:
- Prioritise stability: FMPs offer a lower degree of volatility compared to equity-based investments.
- Seek predictable returns: The fixed interest rate structure provides a known income stream.
- Have a longer-term investment horizon: FMPs often have lock-in periods of three years or more, making them ideal for investors with a long-term perspective.
- Wish to avoid interest rate risk: By locking in the interest rate at the time of investment, FMPs can help mitigate the impact of interest rate fluctuations.
Things to consider before investing in FMPs
Key considerations before investing in FMPs:
- No guaranteed returns: Unlike fixed deposits, FMPs don't offer guaranteed returns.
- Credit risk: Understand the credit quality of the underlying bonds as it impacts potential returns.
- Tax implications: Consider the tax implications, including long-term capital gains tax benefits.
- Liquidity risk: FMPs may have limited liquidity, so ensure your investment horizon aligns with the FMP's maturity.
How are Fixed Maturity Plans different from other debt funds?
Key differences between FMPs and Regular Debt Funds:
1. Investment strategy:
- Regular Debt Funds: These funds are actively managed by fund managers who constantly buy and sell securities within the portfolio to generate returns. The fund manager may adjust the portfolio based on market conditions and investment objectives.
- FMPs: Follow a "buy and hold" strategy. They invest in debt securities with predetermined maturity dates and typically hold these securities until maturity. There is minimal trading activity in FMPs.
2. Maturity date:
- Regular Debt Funds: Do not have a fixed maturity date. The fund manager has the flexibility to adjust the portfolio composition based on market conditions and investment objectives.
- FMPs: Have a specific maturity date, which is aligned with the maturity dates of the underlying debt securities. This provides investors with a predictable investment horizon.
3. Expense ratios:
- Regular Debt Funds: Due to active portfolio management, which involves frequent trading, regular debt funds tend to have higher expense ratios.
- FMPs: The "buy and hold" strategy minimizes trading activity, leading to lower transaction costs and consequently lower expense ratios compared to actively managed debt funds.
4. Investment horizon:
- Regular Debt Funds: Suitable for investors with flexible investment horizons and a higher risk tolerance.
- FMPs: Ideal for investors with a specific investment horizon and a lower risk appetite. Since FMPs have a fixed maturity date, they are well-suited for investors who are seeking to lock in their returns for a specific period.
Conclusion
Fixed maturity plans are a good option for investors who want to earn a fixed and assured return, without taking much risk. They are also tax-efficient and have a low interest rate risk. However, they have some limitations such as low liquidity, high credit risk, and no guarantee of return. Therefore, investors should carefully consider their financial goals, risk profile, and investment horizon before investing in FMPs.
