RBI increases Repo and Reverse Repo rates by 50 bps! The headline on Television and Print media after the monetary policy meet of the Central Bank is a cause of concern not only for the stock markets or corporate India but also for a person on the street who is indirectly linked to the financial markets. This is as a result of the realization that a rate hike would in turn, translate to higher EMIs as loans taken for property/vehicles, etc. would become costlier after the tightening of monetary policy. However, there is one section of Aam Janta who is happy with this decision as banks are vying with each other to divert surplus household/corporate savings by offering the highest deposit rates.
Along with banks the financial space also has mutual funds competing for the surplus money of the retail investors and corporate. The mutual funds advocate the money to be moved into a debt product, namely Fixed Maturity Plans (FMPs); which is being considered as a substitute for Fixed Deposits (FDs). FMPs which underwent a bad phase in 2008, once again gained hype in the mutual fund industry in 2010. This was on the back of the huge liquidity crisis faced in the economy and the tight monetary policy carried by RBI to tame inflationary pressures. This can be seen from the number of FMPs launched in 2010 (340) and 2011 YTD (410) as against 90 in 2009.
FMPs are close-ended debt funds which invest into short-term papers like Certificate of Deposits (CDs), Commercial Papers, etc.The instruments in the portfolio are held till maturity as a result of which interest rate risk is negligible. All FMPs have to be listed on a Stock Exchange so as to allow premature withdrawal for investors. In a rising interest rate scenario, FMPs are usually recommended to investors in the highest tax bracket. This is because, FMPs are considered to be more tax efficient and yield better post-tax returns. As far as taxation is concerned, if an investor holds an FMP, whose time horizon is more than a year then he would be taxed 10% without indexation and 20% with indexation. In the case of Short-Term FMPs (that is less than a year); the investors can look at Dividend option where the dividend distribution tax is at ~ 13.52%. This is against FDs, wherein, the investor is taxed as per the income tax slab. For instance, if an FD and FMP yield a rate of return of 8% for a period of 1 year, then the post-tax return would be 5.36% and 7.20%, respectively. FMPs are a substitute for FDs; however the latter have been considered as a safer investment option by our parents and grandparents due to the safety and assured returns that came with them. However, in the case of FMPs, neither the returns nor the portfolio is known to the investor and this makes it difficult for them to authenticate it.
AMCs and experts are pushing FMPs among investors, however we advise investors to keep the following points in mind before purchasing the product.
1. FMPs work well when the macro-economic scenario is unfavourable, i.e. when interest rates are on an upward trajectory due to inflationary concerns, and the liquidity in the system is negative. In the case of an improvement in the scenario FMPs should not be preferred by the investors.
2. From, the time SEBI prohibited the fund houses from declaring indicative yields and portfolios, the investors have no information except than the name and the tenure of the product. In this case, we advise the investors to look at the portfolios of the FMPs that have already been launched. This would give them an idea of the instruments into which the investor money has been allocated. The investors should also look at the pedigree of the fund house and their strategy in managing short-term funds.
3. Although, SEBI has made it compulsory for fund houses to list the FMPs so that investors who want to go for premature withdrawal can do so. However, we believe that this option is not as liquid as it is considered to be; as a premature exit from an FMP would also prevent the investor to take advantage of the rising interest rate scenario. Hence, only those investors who do not require money for a stipulated time period should go for this product.
To conclude, investors with a time horizon of 1-2 years and who fall in the highest tax bracket can park their surplus money in FMPs.
-Dr. Renu Pothen
The author is a Research Manager at Fundsupermart.com India
DISCLAIMER
iFAST and/or its content and research team
Discover the latest Business News, Sensex, and Nifty updates. Obtain Personal Finance insights, tax queries, and expert opinions on Moneycontrol or download the Moneycontrol App to stay updated!
