What are Fixed Maturity Plans? Who Should Invest in It?

What are Fixed Maturity Plans?

As the name suggests, fixed maturity plans (FMP) are those that invest in fixed income instruments (debt) and have a fixed maturity period. These are closed end mutual funds that invest in corporate bonds, government bonds, certificates of deposits (CD), money market instruments, government issued securities, commercial papers (CP), non convertible debentures (NCD), and so on. FMPs can be subscribed only during the launch period. That is why they are called closed-end debt funds.

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What are Fixed Maturity Plans? Who Should Invest in It?

Who Must Invest in Fixed Maturity Plans?

Net asset value (NAV) is the market value of the securities held by an FMP. Net asset values change daily as market rates changes. The NAV value is declared each day after market hours. This means, FMPs are riskier than fixed deposits.

See Also: Things To Remember Before Investing In A Debt Mutual Fund

Therefore, investors who are capable of bearing market risk and require a higher return than FDs can invest in FMP. They are less risky compared to equity funds. Liquidity is less in FMP. It can be received only after the fixed maturity period ends. So, investors who require investments with high liquidity are advised not to invest in FMPs.

How Does it Work?

Once you invest in a Fixed Maturity Plan, the fund manager will invest the amount in securities with a fixed tenure like bonds, Commercial Paper or Certificate of Deposits. The maturity period of these instruments matches the FMP’s maturity. At the end of the FMP term, these securities are redeemed and principal amount is returned to the investor.

During the term of the FMP, investors cannot redeem the units.  Along with the maturity yield, investors will also receive interest on FMP periodically. This fluctuates and depends on market rates. Unlike FDs, it does not provide a fixed interest on the security owned.

See Also: Debt Mutual Funds - A Complete Insight

Fixed maturity plans v/s fixed deposit

Benefits of investing in Fixed Maturity Plans

• Safe and Secure Returns: FMPs invest in debt securities. Debt securities are safer than equity funds. FMPs invest in government bonds, institutional debt, and highly rated instruments. This means the risk of default (not being able to pay back the debt) is low.

• Interest Risk: Lets say you invest in an open ended mutual fund. A rise in interest rates will reduce the value of debt securities. This will eventually reduce the net asset value. As FMPs are closed end funds, an interest rate change will not affect the debt securities value. So, there is no interest rate risk on FMPs.
• Tax Benefits: When you compare FMPs with FDs or any other debt instrument, tax efficiency is more in FMPs. This will be explained in detail below.
• Lower Expense Ratio: The expense ratio of FMPs is lower compared to open ended mutual funds.

See Also: What are Debt Funds? Do Debt Funds Give Good ROI in the Long Run

Indexation benefit on Fixed Maturity Plans

Indexation adjusts income payments by means of a price index. It is applicable only on long term capital gains (LTCG). Indexation aims at adjusting the purchasing price of investments considering the impact of inflation. This in turn will reduce your tax liabilities.

Two important features of indexation are inflation and capital gains. Inflation is the rise in prices of goods and services with time. Capital gain is the difference in the purchase and selling price of an investment. The difference will be the capital gain of the investor.

• Now indexation considers inflation while calculating the purchase price. Higher the purchase price, lower the profit, hence lower tax payable. Indexation helps to achieve this.
• Financial advisors are of the opinion that FMPs held for a little longer than 3 years, fetch tax benefits applicable for 4 years. This means returns from a three year maturity FMP is considered as long term capital gain (LTCG) and has large tax benefits. Returns earned on FMPs held over 3 years are taxed at 20% with indexation. Indexation makes FMP schemes profitable.
• A person X invests Rs 10,000 in July 2016 in an FMP. The units were bought for an NAV of Rs 10.After three years, X redeems investments in September 2019. The net asset value of a unit is Rs 30 in September 2019. Your capital gain is Rs 2 Lakhs. But you need not pay tax on the entire capital gain. This is the benefit of indexation on long term capital gains.

Indexed cost = (CII for the year of sale/ CII for the year of purchase)* cost of purchase

Indexed Cost = 289 / 264 * 1,00,000 = 1,09,000.

Your long term capital gains after indexation:

Sale Value – Indexed Cost

(3,00,000 – 1,09,000) = Rs 1,91,000. You have 20% LTCG tax on Rs 1,91,000 = Rs 38,200.

Conclusion:

Fixed maturity plans are a good investment option for those who expect to have increased returns with average risk involved. It provides less liquidity as they are fixed tenure schemes. Tax benefits on FMPs are remarkably profitable.

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