Fixed Maturity Plans: A Detailed Guide on Fixed Maturity Plans

Last Updated: 6 Aug 2024

Fixed Maturity Plans (FMPs) of mutual funds are now few and far between. They were quite popular as closed ended schemes wherein investors could put money and match with maturity outflows. However, things changed with the 2014 budget which changed the definition of LTCG for FMPs from 1 year to 3 years.

The result was a massive redemption in FMPs in the year 2015 and 2016 when they matured. However, even with 3 year LTCG definition, there is still a market for FMPs in the sense that one can match it with liabilities since the average maturity of the investment is known due to the FMP commitment.

Would FMPs also classify as a debt fund category?

Debt funds are a very broad category of mutual funds that would invest predominantly in debt instruments like government bonds, municipal bonds, state development loans or SDLs, call money, CP, CD etc. While debt funds in general are open-ended, FMPs are an example of closed ended debt funds.

Being a closed ended fund, FMPS are only available for purchase and redemption at certain interval. A typical closed ended fund collects monies from investors through NFO and then it gets locked in for a fixed period. This period can be as low as 1-3 months or as high as beyond 3 years. Now FMPS are typically locked in for 3 years with a maturity profile of investments that matches with the term to maturity of the FMP. The FMPs are listed.

How is an FMP different from other debt funds?

FMP is a debt fund with some interesting tweaks. Contrary to popular belief, FMPs are not assured return products. However, the returns can be predicted since the portfolio and the maturity is known. That is why FMPs are required to clearly indicate that the returns they show are just indicative and nothing like assured return schemes.

FMP has an indicative return calculated based on what the securities are currently earning. Since the FMP is locked into a fixed maturity, the fund can buy securities that precisely match with the maturity of the FMP. For example, if there is a 3 year FMP then the fund can buy debt securities with residual maturity of 3 years. That way, interest rate risk is eliminated and FMPs become immune to interest rate movements.

Which class of investor should invest in FMPS

You should invest in an FMP if you can lock-in your funds for a certain fixed period and don’t need intermediate liquidity. That is what defines your FMP fitment.

• If you can lock in your funds for 6 months, then you can opt for a 6-month FMP. Similarly, if you have capacity to lock in funds for 3 years then opt for a 3 year FMP.
• Remember, that once funds are locked into an FMP, then interest rate risk is quite limited. You should earn as much as is offered by the securities of matching maturities.
• FMPs are listed on the stock exchange and traded. However, the trading can be often quite thin and prices may not be reflective. Don’t rely on secondary market liquidity.
• In short, the FMPs are a kind of debt fund that is closed ended and hence manages to give indicative returns by matching fund holding profile with maturity period of the FMP.

Can you outline some major advantages of FMPS?

Here is a gist of some of the major merits of investing in a fixed maturity plan (FMP).

• Fixed Maturity plans offer safety and security of debt instruments, which are by default, much safer and more stable compared to equities.
• FMPs can be a good choice if you are looking at stable returns with safety of principal. However, don’t rely on FMPs if you want liquidity.
• FMPs invest in highly rated instruments like government bonds, institutional debt, AAA rated debt wherein the risk of default is much lower and offers portfolio stability.
• FMPs predominantly eliminate interest rate risk for the investor. When you invest in an open ended debt funds, any rise in interest rates will result in a fall in the value of the debt securities. However, since FMPs are closed ended they are locked into fixed returns with limited or no interest rate risk.
• As a result, FMPs can be a good product even in a rising interest scenario or where the central banks are getting hawkish, as is the case now.
• FMPs are more tax efficient compared to bank FDs and similar debt instruments if held for more than 3 years. When you invest in bank FDs or in corporate debt, the interest earned is taxed at your peak rate of tax plus cess and surcharge. However, in case of 3 year FMPs, there is only capital gains where you pay tax at 20% after indexation meaning that your actual tax implication is much lower than that. This makes FMPs more tax efficient form of debt.
• At the end of the day, the tenure of the FMP matters a lot to tax efficiency. If the tenure of the FMP is less than 3 years, it is treated as STCG. That means, capital gains will be taxed at your peak rate of tax applicable. However, if FMP is held for more than 3 years, it becomes long term capital gains and will be taxed at just 20% after indexation.

Can you tell me the benefits of double indexation in FMPS?

You would have often seen FMPs with maturity periods of 1100 days. Why is that so? It is to get the benefit of double indexation in taxation. For example, a typical 3 year period is around 1095 or 1096 days. Instead, if you invest on 29-March 2019 for example and redeem on 02-April 2022, then you have held it for around 1,100 days.

What is more interesting is that you get additional indexation benefit of 4 years instead of 3 years. That enhances your indexed cost of acquisition of the FMP and reduces your taxable capital gains. One of the ways to play the FMP is through the benefit of double indexation. That is why many fund houses actually issue their FMPs around the end of a fiscal for a period of 1100 days and redeem their FMPs at the beginning of the fourth fiscal year.

The additional indexation year makes a big difference. That is what the benefit of double indexation in FMPs is all about.