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The Joy of Predictability

Rising interest rates and uncertain stock markets have sent investors rushing towards safe and predictable fixed-income investments. In this context the rise of FMPs have been truly astounding

It's good to not have to deal with an unpredictable future. We love finding out what's going to happen. This is good business for those who pretend to be able to predict the future. Of course, the desire to predict often outstrips actual ability, as anyone who has been following media coverage of the UP elections knows. Perhaps elections in a complex multi-party first-past-the-post system are not inherently predictable. Apparently, the best strategy is to make lots of predictions and then hope then that at least some of them are less wrong than predictions made by others. Much like the business of predicting the stock markets, in fact.

However, even though the stock markets get all the headlines, an enormous amount of Indian investor money is pouring into predictable investments that would bore stock junkies and media pundits alike. Of all the types of mutual funds that are available to investors, the sharpest rise in popularity has been in that of a little talked about category called fixed maturity plans (FMPs). The rise of FMPs has been truly astounding. In all of 2006, this type mutual fund had a total investment inflow of Rs 89,647 crore. In sharp contrast, the first four months of 2007 alone saw Rs 71,607 crore being invested in these funds. Almost all the money that comes into FMPs is spare parked cash from companies and large investors.

What are FMPs and what is making FMPs so popular? The answer is simple. Rising interest rates and uncertain stock markets have sent investors rushing towards safe and predictable fixed-income investments. And while bank deposits are what individual investors rush to, savvy professional investors know that FMPs are effectively like a bank fixed deposit but one that has a lower tax incidence.

While FMPs and bank deposits have similar returns, income from FMPs attracts only a 14.16 per cent (effective) dividend distribution tax while income from bank deposits attracts income tax at the full applicable rate that is probably 33.99 per cent for most people. This is a very large gap. A fixed deposit that nominally earns 10 per cent p.a. effectively earns you 6.6 per cent while an FMP with a similar yield effectively earns 8.6 per cent. Unlike bank deposits, FMP returns are not guaranteed or even stated up front. However, over the last few months, three to six month FMPs have been yielding over 10 per cent per annum of returns, as compared to bank deposits of similar tenure which have been giving 5 to 7 per cent.

As I said earlier, FMPs are an instrument used primarily by corporate finance types to park spare cash and not by individual investors.

There is no reason that this should be the case-I think this is just a knowledge gap. Of course, FMPs are mutual funds and are thus not theoretically risk-free. However, the way their investments are structured, the practical chances of getting a nasty surprise are very low. In any case, like any other investment, investors should diversify their investments across various providers. The mechanics of investing in FMPs are the same as that of investing in any other mutual fund and may seem more or less convenient depending on how used you are to the process.

One thing is certain. New ways of investing have come to the simple and staid world of fixed deposits also. Better and more tax-efficient returns are available even to small individual investors-it's your money so you really should make it work as hard as possible.