All you should know about Fixed Maturity Plan

What are FMPs?

FMPs are closed ended mutual fund schemes that invest in debt instruments. Their maturity is pre-defined and usually offered for tenures varying from 30 days to 5 years. The most commonly offered tenures are 30 days, 180 days, 370 days and 395 days. As per the Association of Mutual Funds in India (AMFI) data, the assets under management in FMPs has increased by 178 % over the past 12 months ended April 2011 to Rs 1,25,787 cr indicating the rising demand. How do FMPs work?
The basic objective of FMPs is to generate steady returns over a fixed tenure, thus shielding investors from interest rate fluctuations. FMPs achieve this by investing in a portfolio of debt securities [predominantly certificate of deposits (CDs) and commercial papers (CPs)] whose maturity or tenure matches that of the scheme. These securities are redeemed at the end of the FMP term. For example, if the FMP is for 12 months, the fund manager will invest in instruments with a maturity of 12 months only. Since FMPs are closed ended and investors cannot redeem units with the mutual fund during the FMP tenure, the fund manager need not sell any part of the portfolio during this tenure thus locking the yield of the portfolio. This also mitigates the risk of loss on premature sale of securities and lowers the interest rate risk. FMPs, however, are not allowed to provide 'indicative yields' to investors like in the case of FDs, where interest rates are pre-defined. However, in a rising interest rate environment (as is currently prevailing), FMPs will inherently capture this trend. Who can invest in FMPs and what are the risks?
Investors across risk profiles may look at investing in FMPs though it comes with a caveat that they are not completely risk free. FMPs face credit risk, i.e. the chance of loss to an investor arising from the loan default of a borrower who fails to make the promised interest or principal payments (on a security in the portfolio) when due. The risk of default is lower if the FMP invests in high rated debt instruments. Hence it is important for investors to monitor FMP portfolio disclosures. Investors must note that FMPs are structured to offer a combination of capital appreciation and preservation, however, without a guarantee. Hence, FMPs may not necessarily fit into the definition of conventional capital protection debt instruments. Investors may also note that bank FDs upto Rs 1 lakh are guaranteed by the government through the Deposit Insurance and Credit Guarantee Corporation of India unlike FMPs. Further, FDs are relatively more liquid as premature redemption is allowed, albeit at a fee.
What are their tax advantages?
FMPs are a more attractive alternative where tax advantage is concerned vis-