A prudent investor is the one who relies on not only the equity funds to comprise a holistic portfolio, but ropes in debt instruments as well. And what better time there could be to invest in debt instruments than the current one when interest rates are on a rise?
One of the popular debt plans for retail investors who want to rake in a higher interest rate is a fixed maturity plan (FMP). It is also known as a fixed term mutual fund scheme which invests in debt instruments that are set to mature along with the scheme’s tenor.
These schemes lock their interest rates since they are instruments that are held-to-maturity and have a high probability of return. Since they are fixed term, they do not change their duration nor do they change the underlying instruments to add higher-coupon earning papers if those come up post FMP launch.
"Its a good time to invest in FMPs for investors looking to make debt investments with an investment horizon of three years. If we look at the yield on the 10-year Government bond, it touched a high of 7.6 percent in June, and has now moderated to 7.2 percent. We could be towards the end of the interest rate increase cycle, and this presents the investors with a good opportunity to lock-in the current elevated yields for the next three years with the help of FMPs," said Ravi Saraogi, CFA, SEBI Registered Investment Adviser and co-founder of Samasthiti Advisors.
“Fixed maturity plans (FMPs) particularly those over three-year maturity are a good investment option today. Over three years they score over deposits given the long-term capital gains tax with indexation benefits that they offer. The interest rates have reasonably increased over the past few quarters and they are reflecting well in market interest rates. However, not all fixed deposits have been repriced to that extent," says Abhishek Dev, Co-Founder and CEO, Epsilon Money.
Getting the benefit of indexation is quite useful, particularly in view of the rising inflation as it brings the tax liability down. Conversely, in case of fixed deposits (FDs), the entire interest is added to taxpayer income and is taxed as per slab rates.
This implies that your post-tax return from FMPs will be higher than those of bank FDs for the same rate of return especially if you fall in the higher tax slab.
Same time horizon
But before you invest in FMPs, you should make sure that your time horizon coincides with the tenure of FMP and you are content with the current interest rates.
As FMP is a close-ended scheme, its tenure is similar to the duration of debt scheme it invests into. This effectively means that one-year FMP will invest in debt instruments including commercial papers, certificates of deposit, corporate and government bonds, and bank fixed deposits.
Now since the maturity dates of both financial instruments is same, there is practically no risk associated with the rates of interest or reinvestment.
Although the returns may appear higher than those of the fixed deposits (FDs), investors should factor in the fund management fees before opting for them.
Locking interest rates
Experts say that the FMPs are a good investment plan as they offer good opportunity to lock the current interest rates for the next three years while offering the benefit of indexation at the same time.
"If you are looking to lock in current interest rates, over a period of 3 years or more, FMPs do present a good investment option,” adds Abhishek Dev from Epsilon Money.
However, the investors should be cautious since they cannot be redeemed before maturity and secondary market liquidity may or not be able to provide a pre mature exit at the right price if needed, Mr Dev adds.
“Target Maturity Funds removes the fund manager biasness and targets a particular year of maturity and generates the return as envisaged in the form of YTM (minus expenses) at the start of product tenure,” Amar Ranu, Head of Investment Products & Advisory at Anand Rathi Share & Stock Brokers wrote in an article for MintGenie.