An FMP is a closed-ended system offered by a mutual fund, which matures on a sure date, ie, the system runs for a fixed timeframe. The period of maturity can be anywhere between months & years. "When the fixed period comes to an finish, the system matures & your money is paid back to you.

So, in a sense, you could think about FMPs to be fixed deposits (FDs) issued by mutual funds (MFs)," explains Sandeep Shanbhag, director, Wonderland Consultants, a tax & financial planning firm. Currently, FMPs maturing in a tiny over a year (usually 370 days) are the most popular ones. The money collected by FMPs is usually invested in various kinds of financial securities, like certificates of deposit (CDs) issued by banks & commercial papers (CPs) issued by other companies.

The tenure of the FMP is usually equal to the tenure of the financial securities that are invested in. The idea is to lock in the investment at a specified rate of return, thereby immunising the return against any debt market fluctuations.

CURRENT RETURNS ON FMPS

Until sometime back, mutual money were allowed to give out indicative returns on FMPs. This gave investors an idea about the kind of returns they could expect.

The Securities and Exchange Board of India , the stock market and mutual fund regulator, has now banned the practice. However, unofficially, most mutual money do give out indicative returns. The expected return on an FMP largely depends on the returns being offered by the financial securities they have invest in, ie, CDs and CPs.

As Suresh Sadagopan, a certified financial planner who runs Ladder 7 Financial Advisories, explains "The current returns for 90-day CDs are about 9.4% and the one-year return is around 10%. Taking in to account the expenses, the pre-tax return on an FMP could be 0.2% to 0.4% less." This means, most one-year FMPs now offer around 9.6% to 9.8% return, whereas 90-day FMPs offer around 9% to 9.2%. "Returns are around 9.6% to 9.7% for an FMP fully invested in bank CDs," says Vijay Chhabria, a certified financial analyst who runs Prudent Investment Advisors .

WILL THE RETURNS GO UP?

"The returns are expected to go up further as there appears to be more rate tightening feasible. I expect another 0.5% increase in all. The yields for one-year FMPs are already nudging towards 10%," says Sadagopan. Shanbhag expects returns to go even higher than 10%. "Inflation will be an ongoing challenge. Consequently, rates of interest may need to be tightened still further. In such a scenario, could expect returns to touch ten.5% or even 11% pa over the medium term," they says.

Experts are of the view that these returns will go up in the near future as they expect the RBI to raise rates of interest further to tighten the burgeoning inflation. This may increase the returns from CDs & CPs that FMPs invest in, thus pushing up FMPs' returns in turn.

BETTER THAN FDS IN RETURNS

So ought to you be investing in FMPs when returns from fixed deposits(FDs) are also touching 10%? "What gives FMPs the edge is greater tax efficiency. In other words, on a tax-adjusted basis, the return on an FMP is higher than that of a bank FD," explains Shanbhag.

"This is because the interest on bank FDs is fully taxable whereas the return from FMPs is subject to capital gains tax (for the growth option)," they says. Capital gains made on invest-ments in FMPs for a period of over a year are taxable at the rate of 10% without indexation, or 20% with indexation, whichever is lower. Indexation fundamentally takes the rate of inflation in to account while calculating the cost of acquisition of an asset. This ensures that the capital gain is lower, and, hence, lower tax. Also, the current inflation, in the range of 8% to 9%, will make definite that most of the capital gains are not taxable at all. This ensures that the rate of return on an FMP is better than from a fixed deposit even in the event you happen to fall in the lowest tax bracket of ten.3%.

That probably explains why investors are flocking to FMPs. "Most investors who had invested in bank and company FDs a couple of years ago are in the method of liquidating the same and reinvesting the proceeds at a higher yield," says Shanbhag.

HOW SAFE ARE FMPS?

FMPs are safe. "If an FMP is investing only in bank CDs, then there is no risk at all," feels Chhabria. "Most MFs maintain that their FMP products invest largely in bank CDs. After the past experience, financial securities issued by actual estate companies are being avoided largely. However, there could always be the odd FMP which could take exposure to infrastructure and actual estate paper to jack up the yields. In this respect, investors would be better off sticking to offers from pedigreed and reputed funds even if the return is marginally lesser," says Shanbhag.

DIFFICULT TO GET OUT

What investors ought to keep in mind is that it is very hard to get out of an FMP before it matures.

Earlier, if an investor desired to come out of an FMP investment, they could redeem his investment with the mutual fund by paying an exit load of around 2% of the net asset value. Now, a mutual fund is not allowed to redeem an FMP investment.

But there is no liquidity in these schemes, ie, in case you are looking to sell, there's no buyers. "The liquidity is poor. I attempted looking up the FMPs I have invested in on the NSE site & it said there's no trades for the securities," says Chhabria.

These schemes are listed on the stock exchange & the investor can sell his units to any other investor willing to buy.

"Liquidity is an issue with FMPs as it depends on anyone purchasing them from you. FMPs are not liquid from a practical standpoint. They recommend FMPs to only those who can hold them till maturity," says Sadagopan.

Given this, investors ought to invest in FMPs only in the event that they do not need the funds any time soon.

Source: [ET]