how to choose good fmps

8/11/2019 How to Choose Good FMPs

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mutual fund universe till 10

years ago, Fixed MaturityPlans (FMPs) are well on their

way to becoming a major

option for all kinds of

investors. As on Sep. 2013,

FMPs account for 23 per cent

of the assets managed.

Although, individual and

small investors were slower tocatch on to FMPs initially,

their irresistible combination

of higher returns and lower

taxation have made them a

logical alternative not just to

other types of fixed income

funds, but also bank fixed

deposits.

The Logic Of FMPsWhile there

are some

nuances to

investing in

FMPs that you

will have to

understand, the main

argument for FMPs is very

simple-higher returns with

high safety. For those in the

highest income tax bracket of

30 per cent, the effective post-

tax rate of return from fixed

deposits in the last one year

was 6.3 per cent. In

comparison, a typical FMP for

the same period earned areturn of 9.51 per cent. After

adjusting the investment cost

for inflation to calculate the

indexation benefit, the returns

from FMPs become tax-free as

the rate of inflation is higher

than the rate of return.

For longer periods, thisdifference stacks up quite

steeply. For instance, if you

had deposited Rs 10 lakh in a

three year fixed deposit on

April 1, 2010, it would have

swelled to Rs 12.07 lakh on

April 1, 2013, taking into

account the income taxliability. For the same period, a

similar investment in an FMP

would have earned Rs 12.59

lakh, which would be tax-free.

When you look at these

numbers, FMPs appear to be a

no brainer. Why would you

leave that extra money lying

on the table for the banks and

the taxman to pocket it?

Of course, there's a catch.

Rather, there are two catches.

Neither of them are show

stoppers, as the over Rs 1 lakh

crore invested in FMPs show

but you need to be aware of

them before taking the plunge.


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The Liquidity Trap

Unlike bankfixed deposits,

there is no

practical way

to get a

premature redemption in an

FMP, although on the face of it

FMPs work much like a fixed

deposit. You invest in an FMPthat is launched for a fixed

period of time. Generally,

options range from 12 to 36

months. When the said period

is over, the fund redeems your

money with the returns.

However, unlike a bank fixed

deposit, the fund company hasno option for an early

redemption.

Theoretically, all FMPs are

listed on the stock markets

and if you need your money

early, you have the option to

sell it to another investor. But

that is easier said than done.

In practice, volumes are thin

to being non-existent and you

probably will never be able to

sell.

For instance, since January

2013, FMPs were traded only

on 20 days with just eight

schemes changing hands on

the BSE and nine on the NSE.

Even though the traded

volume exceeded a few lakh

for some schemes this year,

historically, it has remained

less than a few hundred a day.

What is clear from this is that

one should invest only that

amount one is absolutely

certain that will not be needed

in the interim period.

Risk InvolvedThe other possible fly in the

ointment is credit risk. Bank

FDs have a very high degree of

safety and FMPs cannot match

FOR UNCERTAIN TIMES

^ upto November; * as on FY ending March 31


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that. Like all

mutual fundinvestments,

FMPs carry

market risk.

The fund

manager deploys FMP's assets

in a range of fixed income

assets and in theory, any of

them could go bad and therebylead to capital loss.

In practice, such a loss has

never happened. There are

two sources of potential

losses in fixed-income

investments. One is a fall in

the market price of the

securities (bonds) that thefund has invested in. FMPs

are immune to the first risk.

FMPs are fixed-period

instruments where the fund

managers only invests in

those bonds that are

maturing just before the

redemption date of the fund.

Therefore, even if the market

price of the bonds fluctuates

in the interim, the final value

realised is not affected.

The other is credit risk, as

in the bond issuer being

unable to redeem the bond

when it matures. Credit risk

can be mitigated by the fund

managers doing their job of

choosing the investmentsproperly. In terms of the

actual investments chosen, 82

per cent of the assets of

FMPs are highly rated papers.

Making the choiceIf you are

convincedabout FMPs,

the next

logical step is

to select one to invest.

Choosing an FMP is

somewhat more tricky than

choosing a normal open-

ended fund, because unlikeopen-ended funds, you don't

have any past performance or

rating to go by. Moreover,

depending on when you

invest, you may not have a

wide choice because you can

only invest in those FMPs

that are starting off with a

timing that aligns with

your needs.

To make investing in FMPs

an easy process, we have

created the Value Research

FMP Selection Framework

which will help you in

selecting an FMP to invest.

The main point about this


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framework is that in the case

of FMPs, you have to evaluatean AMC's past track record of

running FMPs, in comparison

with FMPs from other AMCs.

Moreover, since interest rate

conditions keep varying, this

comparison can only be made

between FMPs that started

and ended at roughly thesame time. Once you analyse

the performance of FMPs by

different AMCs (See FMP

Bouquet) you can zero in on

the scheme of your choice.

Post-2008 Repair

Before the 2008financial

crisis, FMPs

were open-

ended and

exposed investors to higher

risks with the lure of higher

returns. Their popularity was

largely on the higher returns

that they posted in that

period, which overlooked the

inherent risks. Sebi

regulations in the aftermathof the 2008 crisis fixed these

flaws and made FMPs safe

and more transparent.

FMPs were ensured to

become closed-end, doing

away with the open-ended

treatment they followed

before 2008. This way, itensured that there was no

payment crisis on count of

mass exodus by investors

which was witnessed from

FMPs at the height of the

2008 crisis

Fund managers now have

to align the maturity of theunderlying securities with

that of the fund. This was

in departure to the earlier

scenario when FMPs were

actively managed by fund

managers, who took more

market risks to earn higher

returns. Now, investments

are held till maturity.


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When does the term of an FMP

start, from the date of purchase

or the date of closing of NFO?

The term of an FMP starts from the

date of allotment which can differ

from the closing date of NFO. The

allotment process is usually

completed within 5 days of closure of

NFO and the units are credited toinvestors' accounts.

How do I redeem after maturity?

You do not need to file a redemption

request with the fund house at

maturity of the scheme. AMCs are

bound to transfer redemption

proceeds within 10 days from the

date of maturity. The amount you getwill be determined by the scheme NAV

on the redemption date. This amount

will be automatically credited to your

registered bank account if direct credit

option is available with your bank or

else redemption warrants will be

issued to you.

Do I need a demat account forredemption of FMP?

You don't need a demat account to

get the redemption proceeds.

However, you need one if you want to

trade the FMP on exchange before

maturity.

How are FMPs different from

short-term funds?Liquidity is the biggest differentiating

factor between the two funds. While

FMPs are closed-end, short-term

funds are open-ended, meaning you

can enter or exit short-term funds

any time.

FMPs invest in instruments with

same or lower maturity than the

scheme. This means that regardless of

change in interest rates, the returnsthat would be realised are known.

Short-term funds, though, can invest

in instruments with varying maturity,

depending on the fund manager's

outlook for interest rates. So if a

short-term fund has invested in bonds

with longer maturity it can suffer

interest rate risk.

I want to invest in current FMPs

through secondary market. How

do I go about this?

All FMPs have to be compulsorily

listed on exchange. If you are able to

find a seller for the FMP you want to

invest in, you can buy units of the

scheme from the stock market like you

buy an equity share. As explainedearlier, it is highly unlikely that you will

find sellers and therefore low liquidity.

Where can I track currently

open FMPs?

Look at the current open FMPs at

http://www.valueresearchonline.com

/funds/fmpnfo.asp. It is classified in

three groups, based on investmentterm.

FAQs on FMPs


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The Value Research Star Ratings has forlong been the first step to fund selec-

tion. However, in case of FMPs, there is

no such rating. This methodology

addresses this shortcoming. The way our

rating methodology works, we need a

minimum 18-month track record to give

a rating to any fixed income fund. Since

investors can only invest in FMPs at

launch, a rating given after 18 monthswould be useless. In any case, a majority

of FMPs are launched for periods up to

only 18 months. Therefore, we need a

method by which our readers can evalu-

ate FMPs which are yet to be launched.

Here's how to begin:

1. Look at past performance of FMPs

2. Evaluate returns generated by theFMPs of an AMC compared to those

from other FMPs

3. For a fair comparison, FMPs with

same tenure operating at the same

time should only be compared

*Based on the time frames in which

FMPs were redeemed, the tenures were

divided into three categories: upto 1

year, over 1 year to 18 months andthose with more than 18 months tenure.

Average Assets: It is the average of the

last available size of the FMPs of the

fund house in each of three respective

categories launched in the past three

years

**For each tenure, we calculated the

average of all FMPs whose tenure ended

in each month, and then compared each

to this average. However, because the

band of returns is narrow, we only see

how many FMPs came in above average

and how many below. For comparison we

have annualised the returns of the FMPs

with less than one year tenure

***These fund houses havn't launched

FMPs since 2012: Franklin TempletonMutual Fund, Goldman Sachs Mutual

Fund, Morgan Stanley Mutual Fund, ING

Mutual Fund, PineBridge Mutual Fund,

Daiwa Mutual Fund, Mirae Asset Mutual

Fund, Sahara Mutual Fund and Quantum

Mutual Fund.

The percentage under each tenure indi-

cates the proportion of redeemed FMPs.

Methodology


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how to choose good fmps

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