Back in December, the Securities and Exchange Board of India (SEBI) had changed some of the basic rules governing the operation of debt funds in India. These changes had been made in response to the liquidity crisis that some types of mutual funds had faced in October. Fixed Maturity Plans (FMPs) had served as a good alternative to bank fixed deposits (FDs) for many investors. At that time, it had appeared that the changes would kill off FMPs, which were an extremely popular and quite useful type of debt fund.
Now, almost six months into the new regime, it appears that the expectations of FMPs’ demise were exaggerated. There has been Rs 6,000 crore worth of fresh investment into this class of funds under the new rules. Clearly, there is a strong investing need that these funds fulfill. In fact, SEBI’s reforms have been very much in the right direction and have made FMPs a more robust and desirable type of mutual fund.
As they existed earlier, FMPs were mostly used by companies and large investors as an alternative to bank deposits. These funds resemble FDs more than they do other mutual funds. They are closed-end funds, meaning that one can enter them only when they are launched and exit them when their pre-stated term is over. Also, fund companies offered an ‘indicative return’ for FMPs. FMPs invest in debt instruments with the intent of holding them to maturity. This means that regardless of any ups and downs in the market value of the investments, the final earnings are predictable. Therefore, the indicative returns that FMPs provide to investors did reflect the reality.
The other big point about FMPs is tax efficiency. When you put money in a fixed deposit, the interest gets added to your income. In FMPs longer than a year, if you elect to take all your gains as capital appreciation, the taxation is merely 10 per cent or 20 per cent with indexation. That’s generally quite a saving from the tax rate which either individuals or companies would pay on the interest earned from a bank deposit. For shorter terms too, there’s a tax advantage if investors take their gains as dividends.
So far, so good. However, when the liquidity crisis hit, FMPs got into trouble because of the indicative returns and because they were not really closed-end—investors could actually exit them earlier by paying a high load. This resulted in a rush to the exit while funds were left holding bonds that were not sellable during those days. Many funds had to take recourse to large amounts of bank credit to honour redemptions and one AMC—Lotus—was sold off in a fire sale in the ensuing mess.
In December, SEBI decreed that henceforth FMPs would not come with indicative returns and would be genuinely closed-end. Fund companies would have to list them on a stock exchange to provide premature exit. Both changes were entirely sound and not a day too soon. However, it did seem that that was the end of the road for FMPs. Most people in the fund industry assumed that without knowing about returns and without an exit option, FMPs would not be attractive to investors.
However, this hasn’t happened. Even in their new avatar, the basics of a reasonably predictable rate of return and tax-efficiency make these an attractive option. FMP funds may not reach the market share they had earlier, but they actually fit investor needs better in their new form.
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