Right Time to Lock your Money in Long-term FMPs for Stable Gains

Fixed maturity plans of 3- and 5-year tenors are good investment options given the likelihood of an interest rate cut soon.Nikhil Walavalkar tells you about the risks associated with such instruments


Most debt investors are familiar with fixed maturity plans (FMPs) of three months and one year.However,mutual funds have recently started launching three- and five-year FMPs.JP Morgan AMC has closed two schemes of three- and five- year tenures in July 2012,after mopping up.600 core.New fund offer of a three-year fixed maturity plan from JP Morgan AMC is currently on and another NFO of a five-year scheme is round the corner.Reliance AMC closed subscriptions to three-year and five-year fixed horizon funds last week.Industry observers expect more such products hitting the market in the near future.Obviously,the question is: should you look at such long-term products Yields on three-year bonds are attractive.And it makes sense to lock in these yields given the possibility that interest rates may go down from here, says Himanshu Vyapak,deputy CEO,Reliance Capital Asset Management.

Though no fund house can give you the indicative yields or how much return you will get on these products,some back-of-the-envelope calculations can give a hint of the possible returns.AAA -rated corporate bonds with maturities of three and five years are offering yields of around 9.5%.Fund managers also have the option of bonds issued by public sector undertakings with similar maturities and yields.If one assumes an expense ratio in the range of 0.75% to 1%,a portfolio should offer a compound annual growth rate (CAGR) of 8.5%.However,remember that the expected returns will vary depending on multiple factors,including credit quality of the bonds in the portfolio and the rates at which the coupons are reinvested.Thus investors in these products lock in returns with little interest rate risk,as the portfolio comprises bonds that mature in line with the maturity of the scheme and is held till maturity.Investors need to look at these products in the backdrop of an economic scenario that hints at a fall in interest rates.We expect a 100 basis point fall in interest rates over the next 12 to 18 months, says Nandkumar Surti,MD& CEO,JP Morgan Asset Management India.Compared to a close-ended fund of a shorter maturity,investors in a longer-term FMP,like three- and fiveyear,are not exposed to reinvestment risk,as money is locked in for a longer term, says Joydeep Sen,seniorvice president (advisory desk) at BNP Paribas Wealth Management.If you invest in a one-year FMP,you will face the problem of deploying the maturity proceeds after one year at a lower rate.In the recent past,shortterm interest rates represented by interest rates on one-year certificate of deposit (CD) has come down faster than the long-term interest rates.One-year CD rates have come down from 10.15% on April 2,2012,to 9.09% on August 27,2012.As the experts believe that the trend will continue,investors in one-year FMPs may have to invest at a lower rate one year from now.That makes locking in money for the long term even more attractive.Also long-term investing means better tax treatment.FMP is a tax efficient investment option best suited for investors with a low risk appetite, adds Nandkumar Surti.FMPs come with dividend and growth options.Investors with income needs should opt for the dividend option,in which dividends attract a dividend distribution tax of 13.52%.If you opt for the growth option,long-term capital gains tax liability would be lower of 20.6% with indexation or 10.3% without indexation.Though all look good with FMPs,it does not mean you invest all your money in these instruments.

The biggest risk is the credit quality of the bonds.In case of portfolios of three- month and one-year FMPs,investors are used to bank CDs and a small exposure to commercial papers rated below AAA of NBFCs.But as one plans to get into threeand five-year products,bank CDs are no more an available option for fund managers.There is a possibility of a fund manager buying into low-quality bonds to enhance returns.As five years is a fairly long period,it is better to be with the fund houses that stick to high credit quality bonds.Though no fund house can declare the portfolio of a scheme beforehand,you can get a fair idea of what to expect by checking the portfolios of similar schemes launched in the recent past.The fact sheet of the fund house and many web portals,such as Value Research,can help you find it out.If you see a fund house sticking to AAA corporate bonds or PSU bonds,it is highly likely that it will continue with the strategy of not trading risk for extra returns.Another issue with these five- and three-year products is lack of liquidity.Though they are listed on stock exchanges,there is very low probability that you will get to exit,even if you are willing to offer your units at a 5% discount to the prevailing NAV.So if you cannot remain invested in these products till maturity of the scheme,avoid them.If you are keen to invest in fixed income with a three-year timeframe in mind but do not want to lock in your money,you can look at income funds.This route may be a bit volatile,in case there are occasional spikes in yields.