Use fixed maturity plans to tide interest rate volatility if you're okay with lock-in because longer duration FMPs can give up to annualised 7.7 per cent returns, experts tell Tinesh Bhasin.
In the current uncertain interest rate scenario, investment advisors are suggesting fixed maturity plans (FMPs) to investors looking at debt funds.
The pitch: Interest rates may go up from here, so lock in your investment.
Also, if an investor puts in money in March 2018 and the FMP matures after 37 months, he will get indexation benefit for four financial years.
While FMPs do make sense in the current interest rate environment, they suit investors who don't want volatility in their investments and don't mind locking in their funds for slightly over three years.
"If an investor is fine with volatility, then they can look at short-term debt funds that follow accrual strategy and have an average portfolio maturity between two and three years," says Hemant Rustagi, chief executive officer, Wiseinvest Advisors. He feels that open-end short-term debt funds can give marginally better returns.
Fund houses don't reveal the expected returns of FMPs upfront.
But after looking at their portfolios, investment advisors say they would give returns in the range of 7.7 to 7.8 per cent annually if the individual makes direct investment, and around 7.4 to 7.5 per cent annually if he invests through an agent.
Investors can expect similar returns or up to 50 basis points higher returns in short-term debt funds.
FMPs are closed-end debt schemes that invest in a variety of debt papers and hold them until maturity.
As the holdings within the portfolio are not traded, FMPs don't carry any interest rate risk.
They only carry credit risk, that is, the papers they have invested in can face downgrades or can default.
Most mutual fund houses provide an indicative portfolio to investors. Go with the fund house that's investing in AAA-rated papers, even if the returns from them are slightly lower.
While FMPs make sense for the longer duration, financial planners say investors should look at liquid funds for shorter tenures.
It's true that if you invest in a long-term FMP in the month of March, you will get indexation benefit for four years.
Typically, such FMPs are for the duration of 37 to 40 months.
Indexation benefit brings down the tax burden substantially. But, according to certified financial planner Arnav Pandya: "The indexation benefit of an additional year will not make a huge impact towards increasing returns. So, don't fall for that part of the sales pitch."
For investors who can stomach volatility, there are a few other options besides FMPs.
For those with an investment horizon of up to three years, short-term debt funds are an option.
Pandya suggests that investors with a horizon of three-four years should look at dynamic bond funds.
"They took a hit recently, but the fund managers have made the required changes," Pandya says.
To tide over the current volatility, an investor should ideally get into liquid or ultra-short-term funds.
Once there's clarity on interest rates, investors can invest accordingly.
But moving in and out of schemes means paying short-term capital gains tax.
Instead, they can look at dynamic bond funds where the fund manager changes the portfolio actively based on interest-rate movement and other factors.
If you don't need the money for four to five years, Rustagi suggests opting for equity savings schemes.
These are hybrid funds that invest 35 to 40 per cent in equities and the remaining in debt and arbitrage. They are, however, taxed as equity funds.
Illustration: Dominic Xavier/Rediff.com
