Fixed Maturity Plan (FMP)

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 closed-ended debt mutual fund with a predetermined investment horizon. This structure offers investors a fixed and assured return without significant risk exposure. FMPs are an attractive option for those seeking a stable income stream and tax-efficient investment opportunities. Their low interest rate sensitivity further enhances their appeal. 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:

1. 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.
2. 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.
3. 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.
4. 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.
5. 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

Here are some advantage of FMPs:

• Higher return than bank deposits, as the FMP invests in higher yielding securities.
• Lower interest rate risk than other debt funds, as the FMP holds the securities till maturity.
• Better tax efficiency than bank deposits, as the FMP has a lower tax rate and indexation benefit.

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

Here are some limitations of FMPs:

• Lower liquidity than bank deposits and other debt funds, as the FMP has a lock-in period and exit load.
• Higher credit risk than bank deposits, as the FMP invests in corporate bonds and other securities that may default.
• No guarantee of return, as the FMP is subject to market and regulatory changes.

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):

Who should consider such a plan?

Individuals with a conservative investment approach and a preference for predictable returns may find fixed maturity plans (FMPs) to be suitable. These plans offer a relatively stable investment environment, with interest rates typically fixed at the time of issuance. This predictability allows for more accurate financial planning and risk mitigation.

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

Here are some things to consider before investing in investing in FMPs:

• The quality and rating of the underlying securities, as they determine the credit risk and return of the FMP.
• The duration and maturity of the FMP, as they affect the liquidity and interest rate risk of the FMP.
• The tax implications of the FMP, as they depend on the holding period and the type of securities.

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.

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