Should you invest in mutual fund fixed maturity plans

What are Fixed Maturity Plans (FMPs)?

Fixed maturity plans are close ended debt mutual fund schemes which invest in different debt securities like commercial papers, certificates of deposits, non-convertible debentures, G-Secs, SDLs etc. Since FMPs are close ended schemes, they can be bought from the Asset Management Company (AMC) only during the New Funds Offer (NFO) period. Once an FMP closes for subscription, you may be able buy in the stock exchanges using your demat and trading account, if the AMC lists the fund in the exchange and if you can find a seller in the exchange.

As the name suggests these schemes have a fixed maturity; the maturity of the scheme is mentioned in the Scheme Information Document. You should read the Scheme Information Document or the Offer Document before investing. You cannot redeem units of FMPs before maturity. You can try to sell your FMP from your demat account in the stock exchange before maturity but the liquidity of these instruments in the exchange is very low i.e. you may not be able to find a buyer. Therefore, you should invest in FMPs only if you are ready to remain invested till maturity of the scheme. On maturity of the FMP, the investment proceeds based on the maturity NAV will be credited to your bank account.

How do FMPs work?

• FMPs invest in debt securities whose maturities match with maturity of the scheme. These securities are held till maturity and therefore, there is no interest rate risk. Interest rate risk refers to NAV changes of a scheme due to change in interest rates. Interest rate risk has no effect on FMP returns because the securities are held till maturities. On maturity, you will get the accrued interest and the face value (principal) from the bonds.


• Interest rate risk in FMPs is much lower than open ended debt schemes. Even if the fund manager of an open ended debt scheme intends to hold securities in his / her portfolio till maturity (accrual strategy), he / she has no control over redemptions or purchases. If redemptions are more than purchases, a fund manager of an open ended scheme may be forced to replace higher yielding securities with lower yielding securities in a declining rate scenario. This may affect the returns of investors who remain invested. Since redemptions before maturity are not possible in FMPs, interest rate and / or re-investment risk is much lower in FMPs.


• FMPs usually have much lower expense ratios compared to open ended debt mutual fund schemes. Once an FMP fund manager deploys the investment monies of the subscribers immediately after NFO closes, the fund manager simply has to wait till maturity – accrual strategy. Not much ongoing fund management is required apart from monitoring scheme performance because there is no redemption or purchase till maturity unlike open ended schemes. Lower expenses result in superior returns.


• FMPs may be subject to credit risks. Information about intended credit quality of the FMP securities is usually provided in the scheme information document or offer document. You should read the scheme information document and make informed investment decisions. You should avoid investing in schemes where you are not comfortable with the credit quality.

Why invest in FMPs?

• Low interest rate risk since securities will be held maturity, as explained above.


• Higher predictability of returns since securities will be held till maturity and no redemptions are allowed. If a scheme holds securities till maturity, the return of the scheme will be close to the yield to maturity of the scheme portfolio adjusted for scheme expenses (TER).


• Low expense ratio.


• FMP tenures are usually 3 years or longer. Over 3 years or longer maturity periods investors enjoy advantage of long term capital gains taxation. Long term capital gains from debt funds are taxed at 20% after allowing for indexation benefits.

FMPs versus FDs

There are similarities and differences between FMPs and bank FDs. Both FMPs and FDs are fixed tenure or fixed term investments. FDs give assured returns. While FMPs do not give assured returns, since they invest in securities which mature around the time the scheme matures and the scheme hold securities till maturities, you can get reasonably good visibility into returns. The major difference between FDs and FMPs is in tax treatment. FD interest is taxed as per the income tax rate of the investor. FMP maturity proceeds are subject to long term capital gains tax (if the tenure of the FMP is 3 years or longer).

Let us understand the tax implications with the help on example. Suppose Mr A invested Rs 100,000 in a 1857 -day FMP on 14th February, 2016 which matures on 16th March, 2021. Mr B invested Rs 100,000 for the same tenure in an FD. The returns of both the products are 5.3%. Both investors are in the 30% tax bracket. The table below shows the tax calculations for Mr A and Mr B upon maturity (all figures are purely illustrative). You can see that FMP is more tax efficient than FD.

About SBI Fixed Maturity Plan – Series 43

SBI Mutual Fund is launching a Fixed Maturity Plan, SBI Fixed Maturity Plan – Series 43. The NFO is open for subscription on April 27^th and 28^th 2021. The tenure of the FMP is 1,616 days. The minimum investment amount is Rs 5,000. The allotment date is 29^th April 2021. The scheme will mature on 30^th September 2025. The scheme will invest in Government Securities, PSU, Corporate Bonds and money market instruments.

Why invest in SBI FMP – Series 43?

• Government bond yields in the 5 to 10 year range of the yield curve have crept up over the past 3 months.


• Credit spreads (difference in yield between corporate bonds and G-Secs) have also widened between February and March.


• You can lock these yields for the next four and half years by investing in the FMP.


• There is low interest rate risk as the portfolio holdings of the scheme will be held till maturity.


• You will benefit from the long term capital gains taxation of debt funds.

Conclusion

Fixed maturity plans are good investment options to lock in current yields for the investment tenure for long tenures (3 – 5 years or longer). They give stable returns (virtually no interest rate risk) with a reasonable amount of visibility of returns. The biggest advantage of FMPs is in taxation. Long term capital gains tax in debt funds with indexation benefits reduces tax obligations considerably for investors in the highest tax brackets. You should read the scheme information document or offer document carefully before investing. As always, consult with your financial advisor if you have any doubt about the product.