Earlier this month, HDFC Mutual Fund, the country’s third largest fund house, announced the merger of six of its fixed maturity plans (FMP) into HDFC Corporate Bond fund. Elsewhere, and also in March, Aditya Birla Sun Life Mutual Fund announced the merger of 17 of its own FMPs into its low duration Fund and a target maturity fund. Last year, Kotak Mutual Fund too merged a FMP into a corporate bond fund.
Before discussing the pros and cons of such a move, let’s understand why this is happening.
Fixed Maturity Plans are close-ended funds and on maturity, the proceeds are supposed to be returned to the investor.
Unlike open-ended funds that have no expiry date, FMPs have an expiry date after which the investor gets the money back. In open-ended funds, the investor can redeem as and when required.
The issue with FMPs is liquidity. There is no redemption with the asset management company (AMC). For the sake of regulation, FMPs are listed on the stock exchanges, but practically, there is no liquidity and exiting before maturity is difficult.
FMPs have been losing popularity mainly because of the lack of liquidity. Open-ended funds are liquid and one can redeem at any time.
Target Maturity Funds are like FMPs and are liquid. They are gaining in popularity and in times to come, TMFs will replace FMPs.
AMCs are not floating fresh FMPs because they are losing popularity, except for a few being floated here and there. Earlier, FMP investors would be requested to invest the proceeds of a maturing product in another FMP that the AMC would offer. That’s in keeping with the business objective of retaining business volumes, which in this case, are assets under management.
How it works
We get that FMP maturity means money flowing out of AMCs, that fresh FMPs are not being launched, and that AMCs could lose business volumes. So, what do AMCs do?
They merge the FMP with an existing open-ended debt fund. And how does it work? As per regulations, since money is supposed to flow back to the investor on maturity, it requires consent from the investor to merge his/her FMP maturity proceeds into another fund.
It also means that if no communication/consent is received from the investor, maturity money has to flow back. Gone are the days when physical letters used to be posted for an investor’s consent signature. Now, this happens through electronic communication. Only if an investor replies to the AMC with positive consent can the money be merged into a transferee fund.
What it means for you
Your cashflow
If you require money immediately and have a corresponding cash outflow, then you need not give consent. In that case, there is no need for a debate on whether the merger is good for you. In case there is no immediate requirement for money, the parameters are given below.
Also read | Received FMP maturity proceeds? Here are options to reinvest the money for better returns
Tax efficiency
Indexation for the purpose of long-term capital gains tax requires a holding period of three years.
Once you complete three years of holding, you get additional indexation benefit for each incremental year of holding. From this perspective, it is better to not redeem. In other words, if you do not redeem, your tax efficiency continues.
If you redeem and put your money into another debt fund, the cycle starts afresh and you have to hold for another three years to be eligible for the indexation benefit. Though investment decisions should be taken on merit, tax efficiency is a relevant criterion in this context.
What will the new scheme do?
Investment decisions should be taken on the basis of the investor’s objectives, investment horizon, risk appetite and other aspects. The decision on which fund the FMP is being merged with is taken by the AMC. You don’t have a choice from the basket of debt funds with the AMC – you can only agree or opt out. Having said that, look at the profile of the target open-ended fund and if it suits you, there is no problem in continuing. The parameters are:
Portfolio maturity
A longer portfolio maturity means higher potential volatility and vice versa. As an example, if your FMP money is being transferred into a corporate bond fund that has a portfolio maturity of four years, then ideally you should have a horizon of another three or four years. If you have a horizon of another one year, you can redeem at any time, but the returns may be slightly impacted by market movement.
Portfolio credit quality
Assuming you invested in a high credit quality, AAA-oriented FMP, you would like to continue with another fund with commensurate credit quality. You can check the portfolio of the target fund by downloading the portfolio/factsheet from the AMC’s website.
Switch or stay: What’s the best option?
As stated earlier, over a period of time, target maturity funds will replace FMPs. You may invest fresh money in TMFs. For FMP maturity money, the meter for three years for tax efficiency will start afresh if you redeem and invest in another fund. And if the profile of the transferee fund suits you, you may continue with the merger with an open-ended fund."
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