InvestorQ : What is the view about investing in FMPs? Are there still advantages of investing in FMPs for investors?
Neelam Naik made post

What is the view about investing in FMPs? Are there still advantages of investing in FMPs for investors?

Priyanka N answered.
3 years ago

Post the FMPs of HDFC and Kotak postponing their FMP maturities due to default by Zee Group, there has been a general aversion about investing in FMPs. However, FMPs continue to be a very good financial planning product. Here is why.

· FMPs offer safety and security of debt instruments. Debt securities are, anyways, much safer and more stable compared to equities. Of course, look at the FMP portfolio and ensure they do not invest in below par debt. Most FMPs invest in highly rated instruments like government bonds, institutional debt; “AAA” rated debt etc so that the default risk aspect is almost eliminated. With low default risk and limited price risk, FMPs work like an assured return product for investors. But, they are not assured return product and so please remember that.

· You must be aware that FMPs are closed ended funds and hence there is no scope for price risk as funds are locked in. As a result, any rise in interest rates does not have any negative impact on the NAV of the fund. This is specifically useful for institutional investors who need to provide MTM losses in their books. As a result they are the ideal product in a rising interest rate scenario.

· Compared to the traditional bank FD, FMPs are more tax efficient. When you invest in bonds or even in bank FDs, the interest earned is taxed at your peak rate of tax. So if your tax rate applicable is 30% then the tax on your FD interest is 31.2% (including cess; we are assuming that you are not liable for surcharge). In case of FMPs always opt for the growth plan. The dividend plan may not be too efficient as the dividend distribution tax (DDT) is around 29.12% including the surcharge and cess and is almost as high as bank FDs. Ideally prefer a growth plan!

· When it comes to FMPs, the tenure matters a lot. If the tenure of the FMP is up to 3 years, it is treated as STCG. That means, the capital gains will be taxed at your peak rate of 31.2% and hence there is no special advantage in the FMP, except that returns are higher than in case of bank FDs. However, if the FM is held for more than 3 years, then it becomes LTCG and will be taxed at a concessional tax rate of 20% along with the benefit of indexation. Indexation is the benefit that the tax department gives you to compensate for asset inflation over the years. If you bought an asset at half the price 10 years back then it is unfair to charge you the full capital gain. Let us look at indexation and the dual indexation benefit of FMPs in greater detail.

Here is how double indexation works in case of FMPs

Assume that you purchase an FMP at the end of the fiscal year and then sell it after holding it for a little over 3 years and 10 days at the beginning of the fourth fiscal. Your holding period is just a little over 3 years but the benefit of indexation you get is increased by 1 year. Most fund houses issue their FMPs around the end of a fiscal for a period of 1100 days and redeem their FMPs at the beginning of the fourth fiscal year to maximize the double indexation benefits. That is normally the big kicker for FMPs.

FMPs are still a very good product. Just be careful to vet the portfolio of the FMP. That can give you useful insights about the quality of the FMP.