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Prudent Investor

Dinesh Goyal wants to know how an investor can judge the credit risk of an FMP before investing in it

Every mutual fund is coming out with FMP schemes. Will it not be prudent to look into the quality of papers they are investing in? More so since everyone is looking into indicative yields & not quality. How does one judge the credit risk before parking their money?
-Dinesh Goyal

It is always prudent to look at the portfolio of any fund before investing. But in case of FMPs, that's not possible. These are either closed-end funds or an interval funds which is rolled-over at defined periodicity. So you cannot see and evaluate the portfolio of an FMP as it invests only after you have invested. So far, investors have been able to derive tax efficient predictable return from FMPs.

However, in view of the interest rate rise, tighter liquidity situation and deteriorating condition of the companies in the real-estate sector a part of an FMP portfolio of some funds can face default. This can lead to lower than the indicative yield stated by the fund, or no return or the possibility of a capital loss.

Generally speaking FMPs invest in high quality instruments, which have been rated by at least one credit rating agency. In case of investment in unrated papers, prior approval of the board of directors of the AMC or the Trustee has to be obtained. But to enhance the overall yield FMPs may assume high credit risk and run the risk of default.

There are two thing investors can do to guard against such failures: keep away from FMPs indicating very high yield. The old saying that if something is too good to be true, it will be untrue. The other is to keep away from FMPs of a fund family with dominance of low rated papers in their existing FMPs.

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