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Endangered Funds

Once very popular, FMPs have now lost their charm after the liquidity crisis of October 2008

There is absolutely no denying Fixed Maturity Plans (FMPs) were a big hit over the past year, both with institutional players and retail ones. The figures bear testimony to their fan following. According to the average assets under management (AUM) of December 2008, the share of FMPs was almost 17 per cent (Rs 73,150 crore) of the total assets of the mutual fund industry.

But going forward, the question is whether or not they will be as popular in 2009.

Why investors flocked to it
FMPs are schemes launched with a fixed term horizon, which could vary from one month right up to 13 months, though have been known to go up to three years in a few instances. Since the tenure was fixed, the fund would purchase assets which have maturity profiles in line with the scheme's maturity. This fixed time frame would also permit them to offer an indicative return. Once the scheme reached maturity, the assets would be liquidated and the proceeds distributed among the unit holders.

The FMPs would be close ended in the sense that they would stay open for a few days permitting investors to buy into it and then they would not permit any further investment into the scheme. However, the investors did get an exit option before the actual maturity. In that sense, they were not typically close ended in the real sense of the word.

Though such an exit attracted a certain load, generally ranging from 0.50 to 3 per cent, investors exiting before maturity of the scheme were still able to walk away with higher returns on their investments as compared to bank fixed deposits in most cases.

The popularity of FMPs stems from the fact that they do offer an indicative return. They also offer a fixed time frame within which that return would be given and they are more tax efficient than fixed deposits.

Why fund houses are shunning them
From the asset management company's (AMC) point of view, FMPs are a great way to increase their assets under management (AUM). Another advantage is that they can be customized to a large extent for big investors, who hold the majority share in this asset class. And AMCs went all out to woo the institutional players.

The problem took place in October 2008 when a liquidity crisis saw massive institutional redemptions in FMPs. To add fuel to the fire, questions and doubts on the prevailing portfolios of the fund houses began to emerge.

Eventually, the mutual fund industry was able to survive the crisis with the backing of the Securities and Exchange Board of India (SEBI) and the Reserve Bank of India (RBI) which took drastic measures to help these fund houses meet their liquidity needs. Though no defaults were reported on part of the fund houses, confidence was eroded.

Then came the SEBI ruling on December 11, 2008 stating that all closed ended schemes (except Equity Linked Savings Schemes - ELSS) to be launched have to be mandatorily listed a stock exchange. Furthermore, mid-term exits were restricted to prevent such a situation from recurring in the future. This meant compromising on an important feature of FMPs. Only one FMP has been launched since then.

FMPs did not have simple mark-to-market rules. So the AMCs were hit with the liquidity crisis because they allowed institutional investors to exit at high net asset values (NAV) based on the yield at maturity. Following the crisis, the valuation norms for debt instruments were also changed. Fund houses are now given the flexibility to value the instruments with higher discretion in view of the liquidity and issuer class risks. Maximum discretionary discount of 450 basis points over and above the mandatory 50 basis points was allowed in case of unrated debt instruments with maturity of less than two years. This was a big relief to the investors who were still invested in the schemes after the big investors had withdrawn, for the redemptions being made at the prevailing NAV were now at a discounted price. This also acted as deterrent for mid-term withdrawals.

The future?
Taking into account the developments of 2008, we do not see much of FMPs in 2009. Consider this: In November and December after the liquidity crisis barely 7 per cent of the total FMPs of 2008 were launched.

This is partly because of the complexity that new launches will involve given the listing norms, and also due to the fact that the industry does not want to serve the institutional investors in the way it had been doing till date. The focus has now tilted substantially towards the retail investor. Though retail investors favoured this product, they probably won't see much of it in the future.

In view of the slowing economy, falling inflation and the credit squeeze, interest rates have declined and will continue to fall. Since September 2008, the Cash Reserve Ratio (CRR) has declined by 400 basis points and the repo rate by 350 basis points.

In a high interest rate scenario, which was the case for the most part of 2007 and 2008, FMPs were a hit by offering 11 per cent, and even more at times. The assets of FMPs, after touching an all-time high in September 2008 had fallen by 20 per cent (month-on-month) by December. But with FMPs losing in popularity and interest rates declining, money has been flowing into income and gilt funds with assets going up by 71 per cent and 100 per cent (month-on-month), respectively, by December.

And, they have been performing well. Income and gilt funds gave their best quarterly returns (as on December 31, 2008) of 9.72 per cent and 20.68 per cent, respectively. For most, it was even their best month/quarter. Forget about FMPs. 2009 is the year for income funds.

FMP Standing
Fund House  Market Share in FMP (%)  Share in Total Assets (%)  Assets (Rs Cr.)  Total Assets (Rs Cr.)
Reliance 21.76 22.68 15,922 70,208
HDFC 12.42 19.44 9,088 46,757
Birla Sun Life 8.39 16.77 6,136 36,581
ICICI Prudential 7.51 13.11 5,495 41,902
SBI 6.31 18.46 4,614 25,001
Kotak Mahindra 5.56 28.12 4,069 14,471
HSBC 5.34 38.47 3,903 10,145
UTI Mutual Fund 4.77 8.21 3,492 42,548
Franklin Templeton 4.3 16.19 3,144 19,419
Deutsche 3.48 36.19 2,548 7,041
Fortis 3.46 48.67 2,533 5,204
Sundaram BNP Paribas 3.04 23.1 2,225 9,631
DSPBR 2.83 15.52 2,073 13,356
Tata 2.23 9.27 1,628 17,556
IDFC 2.22 18.27 1,622 8,879
LIC 1.76 9.56 1,290 13,492
Data are as of December 31, 2008