Fixed Maturity Plans....(Returns)Lock Kiya Jaye

Whenever, we think of fixed returns, the first investment avenue that comes to our mind is the traditional fixed deposit (FD). We often tend to follow these investment avenues as they are considered safe and provide fixed returns. But Fixed Maturity Plans (FMPs) is another avenue which should be considered before we make an investment decision especially when you need tax efficient and inflation adjusted returns. Let us explore what FMPs are and how they score over a bank FD.

What are FMPs?

FMP's are equivalent to a Bank FD in a mutual fund but unlike FDs it cannot offer a fixed return. However, by nature the returns on the FMP are locked as all the investments are held to maturity. As the name suggests, the maturity of securities in portfolio equates with maturity of the FMP. FMP's fall under the closed ended debt category of mutual funds which has exposure only to fixed income securities for different maturity periods. The primary objective of a FMP is to generate income and protect fluctuation in the capital due to interest rate variations. They are also known as fixed tenure funds and fixed horizon funds.

FMPs have exposure to high quality bonds (generally AAA/AA rated). Being a debt fund, the portfolio is more tilted towards fixed income securities like certificate of deposits (CDs), commercial papers (CPs), corporate bonds, pass through certificates (PTC), government securities etc. The exposure across different debt instruments makes it more attractive and reduces the portfolio risk.

FMP's come with different maturities like 1 month, 3 months, 6 months, 1 year till 3 years. The different maturities provide an option to investor to choose an FMP as per their investment horizon.

Also one important point to note here is that unlike other debt funds, the fund managers need not undertake the review of portfolio because the instrument in portfolio matures with the tenure of the scheme. Thus, the expense gets reduced to a great extent.

How FMPs score over FDs:

The biggest difference between a Bank FD and an FMP is the Income Tax Arbitrage opportunity available. FMPs (if you have opted for Growth option) is taxed as capital gains and if you have opted for dividend option, it attracts Dividend Distribution Tax (DDT). The below illustration explains how one can optimize their tax liability:

Investment of Rs.1,00,000 in FMPs & Bank FDs for period of 1 year

	Bank FD Rs.	FMP Rs.
Investment  Amount (A)	1,00,000	1,00,000
Returns (% per annum) (assumed)	9%	9%
Time Horizon	367 days	367 days
Maturity Amount (B)	109049	109049
Interest/Capital Gain (C) = (B-A)	9049	9049
Cost after inflation – with indexation  (100000 )*924/852  (D)	NA	108450
Net Taxable Income – with indexation (E) = (B-D)	-	599
Tax Payable (assumed 30.9%) on Bank FD (F)	2,796	-
Capital Gains (@ 10.3% of (C) – without indexation	-	932
Capital Gains (@ 20.6% of (E) – with indexation	-	123
Post tax Return (C – F)	6253	8926
Post Tax Return (%age)	6.25%	-
Post Tax Return- with indexation (%age)	-	8.93%

*Cost Inflation Index (CII) for 2011-12 -785 and for 2012-13 -852, it is assumed cost inflation will rise by 9% as in the past.

Capital gains tax is 10% without indexation or 20% with indexation whichever is less

On a pre tax basis one is not able to make out which investment avenue is better, but as seen in the above example the impact after reducing taxes is indeed very significant. An investor can get 42% more return than a FD.

FMPs are best suited for investors (especially  above the 20% tax bracket) who are looking for a risk free investment avenue.

To conclude, although bank FDs offer guaranteed returns and FMPs cannot, there is merit to investing in FMPs vis-a-vis FDs due to higher tax efficient returns offered by FMPs. However, there is one limitation with regard to liquidity. Even though these are listed on the Stock Exchange, there is no liquidity and typically the investor has to hold the investment till maturity. In the present scenario, owing to higher inflation, interest rates are high, this will gradually decrease hence time is ideal to lock your investments in FMP's


Ninad Kamat CFPCM
www.letsmakeaplan.in
facebook
Data Source: Juzer Gabajiwala Director- Ventura Securities
Image Source: Onemint.com