What are Fixed Maturity Plans (FMPs) and who should invest in them?

Fixed Maturity Plans are a category of debt mutual funds that are currently attracting the attention of Ultra HNI and retail investors alike. With the debt market looking fragile and the 10 year Gsec yield on a back breaking spree, are FMPs the next alternative investment solutions that can save the investors from interest rate risk? Are FMPs for you, read to find out.

Fixed Maturity Plan or FMPs are close ended debt mutual funds that have a fixed maturity period. The AMC launches a New Fund Offer (NFO) and inviting subscription to scheme. Unlike an open ended scheme which stays open for subscription all the time, a FMP remains open for a limited period. The NFO will have a launch date and a closing date till when an investor can subscribe to the fund and after it’s maturity the fund ceases to exist. In the interim, an investor can trade the FMP on the stock exchange.

Where do FMPs invest and what are the indicative returns?

Being a debt fund, FMPs invest in debt securities like corporate and government of India (GOI) bonds, Non Convertible Debentures (NCD), and liquid instruments like T-bills, Repo, Corporate Deposits (CD) and Commercial Papers (CP), based on the market yield and the scheme’s investment objective, an FMP could invest in AAA to A+ rated securities with varying credit risk.

With the 10 year G-sec yields having crossed 7.9% mark, the bond yields too have surged. Now a portfolio of high quality of AAA rated securities can easily give a return in the range of 7.7-8.4% thus making them very attractive.

What is the maturity of an FMP?

The maturity of an FMP is similar to the maturity of its underlying assets. Since the FMP exists for a fixed period which is defined during the subscription of the NFO, it invests in debt securities with similar maturities such that they mature on or before it’s maturity date.

Eg: If the Fund has the maturity period of 1110 days then it will pick instruments that will mature on or before 3 years.

The fund manager of a close ended FMP follows a passive investment strategy where in they buy and then hold securities until they mature. Therefore there is minimum churning unlike in a open ended fund where the fund manager churns the portfolio more regularly based on his strategy and market outlook.

This helps an FMP keep its expenses lower.

How are they taxed?

Most FMPs have a maturity of 3 or 5 years. Being a debt fund, the biggest advantage of investing in a FMP is the indexation benefit that an investor receives after completing 3 years.

Although it is similar to a Fixed Deposit, the tax benefit that an investor earns makes an FMP triumph over any FD or NCDs.

Assume you had invested Rs 10 lakhs in a FD and FMP with the maturity of 5 years. Even though return generated by an FMP is higher, to level the playing field lets consider both had generated a return of 8%.

As you can see from the table above, you can potentially save Rs 1 Lakh in taxes by investing in an FMP. Even for an investor in 20% tax bracket, the post tax corpus earned from an FD would be significantly higher than a bank FD.

What are the drawbacks of an FMP?

Being a close ended fund an investor can’t redeem the units until the FMP matures. However, the investor does have an option of early exit through a stock exchange. For this the SEBI has mandated the FMPs to be listed on the stock exchange. The problem is that there is little demand for them in the secondary market and even when there is a buyer the price offered is lower than its NAV.

So an investor must subscribe to an FMP with an intention to keep their money locked-in for the duration of the fund and with the knowledge that this money would not be needed in the interim.

Also the indexation benefit can be enjoyed only if the debt fund investment has been held for 3 years, so it would be ideal to pick FMP with a maturity of at least 1100 days which is just a few days over 3 years.

 

Who should invest in a FMP?

Unlike a debt fund, an FMP is insulated from the interest rate volatility since the fund manager buys and holds the securities until maturity. Thus the returns of the FMP are less impacted by the price fluctuations triggered by the swinging interest rates of the market.

Therefore, HNI, ultra HNI in the highest tax bracket, retail investors and even senior citizens can benefit from investing in an FMP as the yields offered are competitive and the capital gains are taxed with indexation benefit making FMPs a very attractive investment solution in the tumultuous and uncertain interest rate scenario.

 

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New Mutual Fund Classifications – What you should know

The universe of mutual funds within the Indian space is quite big; as per latest data on AMFI, to be precise. So it’s not particularly easy for an investor, especially a first time investor, to navigate through it to identify the right kind of mutual fund for his/her requirements.

In response to fund houses launching multiple schemes in one category, which confused investors, market regulator SEBI has come up with a new system for fund classification. The new system aims to bring uniformity to the schemes launched by different fund houses, thus facilitating scheme comparison across fund houses.

Based on the categories, mutual funds will be forced to either merge, wind down or change the fundamental characteristics of a particular scheme. This move could also have short term impacts on the portfolio on any investor depending on the schemes they have currently invested into.

As per the new classification, all open-ended mutual fund schemes will be placed under the following categories:

• Equity
• Debt
• Hybrid
• Solution-oriented
• Others (index funds/ETFs/fund of funds)

Only one scheme per category would be permitted except index funds/ETFs, fund of funds and sectoral/thematic funds.

However, each of these categories will have sub categories:

• Equity will have 10 sub classifications
• Debt will have 16
• Hybrid will have 6
• Solution Oriented will have 2
• Other will have 2 sub classifications.

That is a grand total of 36 classifications an investor can choose from.

As such, these new classifications will have varying impact on existing funds and consecutively on an investor’s portfolio. Such impacts could include:

• Schemes will be forced to stick to their mandate:Funds often change their investing style based on market conditions. For example, a large cap fund may have sizeable mid cap exposure because its chasing higher alpha. But now, any drastic change will force the scheme to change its characteristics resulting in the same being communicated to the investors. So now the investor will not have to worry about the fund becoming something it originally was not set out to do.
• Like for Like Comparison:As AMCs will have one scheme per category, it will be easier for the investor to compare the options available. All schemes of different AMCs of a category will have similar styles and characteristics, which will result in a “apples to apples” comparison.
• Better choice by fewer options:With AMCs forced to ensure one scheme per category and fund labeling to be made in line with investment strategy, options will become lesser which should result in investors being more aware of their choice.
• Need for review in the short term:With the latest mandates, one can expect a short period of fund houses realigning their products. As such, many schemes may end up being quite different they what they originally were. Therefore, investors may need to keep a thorough eye on their funds to watch out for any changes that may occur and act accordingly.
• Possibility of reduction in performance:Like mentioned above, funds often change their investing styles to generate significant alpha. But after these regulations, alpha creation may be more difficult as the universe of stocks will be same for all schemes in a category. Furthermore, as per the latest mandate, if a fund wants to be categorized say as a large cap, it will have to invest only stocks defined as large cap as per regulations. So in the short term it may have to sell or buy some stocks which could have an impact on cost that would be borne by the investor. Also, as regulations would demand funds to rebalance their stocks as per the semi – annual publications of AMFI which enlist large, mid and small cap stocks, it may result in forced selling to accommodate any change in status of a stock, resulting in a possible negative impact on the performance of the fund.

Overall, while there may be short term practical hurdles for both investors and fund houses alike while adjusting to the new mandates, the general consensus has been that this move is a positive step taken by the regulators in the right direction as it will bring reliability and simplicity to investors. For any investor, it would be prudent now to get professional advice on how such changes may impact their own portfolios.

 

 

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Ready for life transitions?

Harsh and Harshita were our usual client couple, happy go lucky, no worries, successful in their careers,  double income, company accommodation, company car, company perks, and you name it.

As they came in for the customary annual plan review meeting, they seemed a little distracted. This was not their usual selves and obviously, the planner in me quickly moved to FPG mode (friend , philosopher, guide ) to understand what’s happening and where I could help.  After some chatting, I gathered Harsh had quit his job as his organization was moving to South India for consolidation reasons. Harshita was apprehensive as they were expecting a baby and she was planning to take a break for family and care giving reasons. Obviously as informed clients, they understood their financial plan and investments needed to be looked at afresh.

Their case is no different from the many life transition situations that we face in numerous client interactions. Infact today, more than ever, most clients are facing multiple life transitions without even realizing so.

Some examples of life transitions are:

• Children moving out of home for education reasons / marriage
• Becoming a parent
• Job losses / Job changes
• Becoming  an entrepreneur
• Divorce
• Widowhood
• Sudden inheritance
• Retirement
• Dependent parents and long term care
• Sudden illnesses and associated medical expenses
• Sudden Demise of family member

In all cases of life transitions, there is a commonality. The commonality is that whether one realizes or not, these life transitions affect your finances. Even if there is no direct impact, these life transitions usually tend to affect one emotionally thereby leaving lesser time and mind space to focus on your finances.

These transitions also naturally do tend to unsettle your financial plans at different points. Although I don’t profess to be a crystal ball gazer and don’t expect clients to be one, the only way life transitions can be actually managed is by putting thought to what surprises life may throw up at you and be prepared for these transitions. Essentially a Plan B.

Besides emotional support from family and friends, the client’s own preparedness would be the other weapon to take on life’s surprises. If you are already going through one of these transitions or foresee it in the near future, please talk to your financial planner about it. If not, prepare for it anyways.

Author – Shalini Dhawan

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A 12 step guide to managing your money in 2012 – IV

We are now in the final quarter of addressing one of the biggest myths about managing money that is, managing money is all about returns on your investment. Whilst returns are no doubt an important component of managing money, we believe it is critical to take a more holistic view on finances. A quick recap on what we have already covered as to do items for quarter 1, 2 and 3

January – Put it all together

February – Question what you really want your money to do for you

March –  Keep what matters, let the rest go

April – Plan for emergencies and contingencies

May – Put your risk control mechanisms in place

June – File your taxes correctly and diligently

July – Use technology to improve the management of your finances

August – Build a team of trusted advisors

September – Build your succession plan

October –   Invest in yourself – There is a tendency to go into a comfort zone with respect to our professions and careers, especially as we become masters at doing the same thing over and over again. Macolm Gladwell in “ The Outliers” has shared a 10000 hour rule which I’m sure a lot of you already know about. For those who don’t, the 10000 hour rule indicates that mastery in a field is driven by spending 10000 hours in it. So what happens after you have spent 20 hours a week doing the same thing for 10 years? Maybe its time to move your cheese before someone else does that for you. Just like companies spend a significant portion of their revenue on research, how many of us have a financial plan that includes spending a portion of our income( or our wealth) on improving ourselves. As Warren Buffett says “ Investing in yourself is the best thing you can do.”

November – Accept that you are an investor – Whilst most of us start off as investors, there is a high risk of becoming a speculator along the way. The difference between an investor and a speculator is two fold in our opinion – firstly, an investor thinks more with his brain and less with his eyes,  and secondly, an investor knows what he owns, why he owns it and can explain that clearly. Avoid buying an investment just because it has done well in the recent past or because it excites you. As George Soros says” If investing is entertaining, if you’re having fun, you’re probably not making any money. Good investing is boring.” In case you cannot avoid speculating, restrict it to a very small portion of your portfolio and understand that you are speculating, not investing with that portion of your wealth.

December  – Review your plan and rebalance your portfolio – Whilst its great to have a plan and even better to implement it, its important to ensure that it is on track to deliver what was expected from it. Whilst different types of investments deliver results over different time frames, it is critical to evaluate that the overall plan is moving in the direction that you wanted it to. Whilst it is good to spend some time on the specific products that you have invested in, the overall allocation across different asset classes is ideally where the focus should be, so that assets that have become cheaper can be added to in the portfolio, and more expensive assets can be reduced. This simple strategy of rebalancing, at least once a year, can make a significant difference to your overall portfolio returns.

Whilst we are already at the end of February now, it is never too late to start in case you have not started implementing this calendar already.

This article was written by Vishal Dhawan, CFP^CM

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Wealth protection gets a new meaning – headline

TWO EVENTS over the last few days have hit the headlines one from India and the other from Pakistan, in which the person with the mandate to protect has done quite the opposite. Both unfortunate events the killing of a leading politician by his bodyguard in Pakistan, and the significant financial losses caused by a relationship manager closer home, have driven home the point clearly that whether it’s your life or your wealth, you need to take responsibility to protect it yourself.

While protecting your life is not something that I pro-fess to have much expertise in, protecting yourself from financial fraud can definitely be minimised by greater alertness and awareness. Unfortunately, investors spend far more time buying a television set than investing five times the amount in a financial product.

Betrayal of trust does create a lot of angst, so it is critical that investors take referrals from friends and family before choosing a financial adviser. Unfortunately, a lot of investors choose their financial advisor based on the rice the cheaper the better, which is contrary to what they do when they buy other products where the belief is that the more expensive the product, the better the quality.

Once the due diligence on the advisor has been done, what can an investor do to protect oneself:

■ As investors seek new products, financial product manufacturers tend to create exotic instruments to fulfill that need. Investors need to stick to products that are more transparent and where risks are clearly understood. Remember the mortgage backed securities in the US a couple of years ago that took some big names down with them or guaranteed return products that did not even return the principal, forget the guaranteed returns.

■ Multiple products today use back testing data, which essentially demonstrates how the product would have performed over different time frames.

This is different from actual performance and is exposed to the risk of data selection bias. Ideally, the track record should be independently verifiable. For example, mutual fund performance data is available on independent websites, so investors can do their own verification of performances and track records.

• Any product that offers returns that are completely out of sync with competing product returns needs to be closely subscribed. In an era, where fixed income returns range between eight and ten per cent, a guaranteed return of more than 15 per cent should definitely cause you to do a significant amount of homework.
• While time is definitely at a premium for everyone in today’s busy world, time spent on understanding where you’re putting your money is definitely time well spent. Avoid signing blank documents and cheques just because you don’t have time.
• Many investors have small sums of money in multiple investments making them very difficult to track.

With larger chunks of money in each investment, you will tend to give it more thought both at the time of investment and also monitor it on an ongoing basis.

This article was written by Vishal Dhawan, CFP^CM and appeared in the Deccan Chronicle  on  8^th  January 2011 .

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