There is one debt fund category, which is not much talked about but has the necessary ingredients to attract investors. This is the Fixed Maturity Plan. This category is ideal for those investors who have ideal cash for a short time.

FMPs are debt schemes that aim to give a fixed return over a fixed period of time. These schemes are mostly closed ended but there is generally an exit option subject to an exit load. As the name suggests, FMPs are available for a fixed term and therefore, it is easier to predict the returns, as the term is known in advance.

The strategy is to invest in bonds that have the same term to maturity as the fund. For, example, if the term of the fixed maturity plan is for one year and six months, then the fund will invest in bonds that have an average maturity of one-end-a-half years. And then these bonds will be held till maturity. Therefore, at the time of investing, the fund will know the approximate yield from every investment.

Unlike other debt funds where the main source of income comes from trading in bonds, FMPs survive on coupon income and not trading income, as they hold the bonds till maturity. This strategy protects the fund from interest rate fluctuations that may happen during the term of the fund.

These funds have a passive management style, as once the bonds of matching maturity are bought, there is not much that the fund manager has to do. Since this is a defensive strategy, the returns will also be less than other debt funds, where funds are managed more actively and therefore, returns are more along with the risks.

Fixed Maturity Plans: Short & Sweet

FMPs are entry-level mutual fund products and are easier for the investors to understand as they offer a definitive term and also give an indication of the yields that the investor can expect.

The main difference between regular debt funds and FMPs is in the risk profile. Other debt funds are typically exposed to three types of risk - interest rate risk, credit risk and liquidity risk. Interest rate risk because the fund is constantly buying and selling bonds and therefore, is exposed to any interest rate fluctuations. Credit risk because if any company whose bond the fund holds is downgraded, the entire fund will take a beating on valuation. Liquidity risk as there can be huge redemption pressure any time and the fund may have to sell its holding at a short notice and sometimes at unfavourable prices. FMPs, on the other hand, by the virtue of being closed-ended, face only credit risk. The interest rate risk is taken out, as the fund manager holds the instruments till maturity thereby getting a fixed rate of return. Credit risk is also not an issue since most FMPs nowadays invest in only AAA – rated papers and thereby, contain credit risk. The liquidity risk is not present as firstly, the investment is done in short term papers where the risk is lesser and second, the fund is closed-ended. There is less danger of huge redemptions coming up as investors have a profile to hold till maturity. This does not imply that FMPs are free from risk but the degree of risk is less. Another point in favour of FMPs is the low transaction costs of these funds as the securities are held till maturity and lesser churning reduce cost.

Since these plans aim to give direct competition to term deposits, compare the returns of FMPs of varying maturities with those of term deposits. It has been found that FMPs with maturities of more than a year have been able to beat the returns from term deposits, but not FMPs with a less one – year perspective.

Indexation Benefit.

What makes FMPs really attractive is a three-year indexation benefit that could make the return of the fund very tax efficient. Let’s say the Fixed maturity Plan earns a 6% return per annum till maturity. This means that for 2.5 years, the investor earns 15% return. If during this time the inflation index rises by 5% every year, then over 2.5 years, inflation would have gone up by 15% as well. Now, by subtracting the indexed cost, the gain after indexation will become zero and no tax will have to be paid. If on the other hand, the inflation index goes up by 6%, then the total increase in inflation after 2.5years will be 18% and then the investor can actually claim a 3% capital loss. (Refer to the Indexation Benefit table). Indexation benefits can be claimed even if the investors holds the plan for a part of the year.

Before investing in FMPs, investors should be clear about the expected returns and the various loads that these funds levy. Even though most FMPs are closed-ended, they offer an exit option, subject to exit loads.