Fmp

Fixed Maturity Plans

S. No.

Topic

Page No.

1 2 3

Fixed maturity plans 3 Features of FMP 4 Common things about 5

4 5 6

FMP Advantages 7 Problems in FMP 10 Sebi Drafting norms for 13 FMP

7

Bibliography

21

FIXED MATURITY PLANS INTRODUCTION

F-12

Page 2

Fixed Maturity Plans FMP’s are closed ended debt oriented mutual fund schemes with a defined maturity period such as monthly, quarterly, half yearly, annual plans with maturity of more than one year, to suit various needs of investors. FMP’s are open for subscription only during a specific period at the time of launch of the scheme which is generally two to three days. FMP’s are debt schemes where the corpus is invested in fixed income securities. Fmp new fund offer are generally open for two to three days and are marketed to corporate and well heeled, high net worth individuals. Minimum investment is usually five thousand rupees. FMP’s usually invested in certificate of deposits (CD’s), commercial papers money market instruments, corporate bonds and sometimes even in bank fixed deposits. Depending on the tenure of FMP’s the fund manager invest in the combination of above mentioned instruments of similar maturity. The fund received is for pre specified tenure and the exit load from the span is high, so the fund manager has the liberty to deploy most of the funds mobilized under the scheme of FMP. INVESTMENT OBJECTIVES OF FMP’s FMP’s seek to achieve growth of capital by investing in a portfolio of fixed income securities normally maturing in line with the maturity profile of the respective FMP. FMP’s yield competitive and tax efficient returns with minimal risk along with good duration management being the key focus

. WHO SHOULD INVEST IN FMP’S? •

Investors seeking to invest for a fixed term.

•

Investors looking for higher tax efficient returns compared to fixed deposits and liquid funds.

F-12

Page 3

Fixed Maturity Plans •

Investors who are looking at debt oriented products which could give steady and competitive returns.

FEATURES OF FMP’s 1. Products with various maturities - FMP’s are available with numerous maturity options

monthly, quarterly, and half yearly and annual plans with maturity of more than one year. The maturity period could go up to three years or even five years. You can invest in the relevant plan depending upon your investment horizon and the requirement of cash flows on maturity. 2. Minimal Risk – Unlike normal open ended debt funds, which are exposed to three kinds of risk viz. interest rate, credit and liquidity risk, FMP’s are a better option. •

FMP’s are least exposed to interest rate risk since the asset liability mismatch is at the minimum. Moreover the maturity profile of the securities is in the line with the maturity of the plan so there is also low credit risk with the minimal liquidity risk involved.

•

The portfolio is mainly a high credit quality portfolio substantially investing in AAA, P1+ or such kind of instruments thereby aiming to reduce the overall credit risk of the portfolio.

3. Tax efficiency of fixed maturity plan of mutual funds vs. fixed deposits. Fixed deposits

are the closest and the most traditional investment avenue when it comes to comparison with FMP’s. Though being mutual funds schemes, FMP’s cannot offer guaranteed returns, they are expected to yields market related returns or better. 4. Indexation benefits - With the help of FMP’s you can get indexation benefits, which is

not available in case of fixed deposits.

Common things about FMP Do they (FMPs) have divided option? And what's the tax implication on it? F-12

Page 4

Fixed Maturity Plans Yes. In most cases half-yearly dividend option (payout / re-investment) is available. Dividends are tax-free in the hands of the investors. Dividends of mutual funds attract only a dividend distribution tax of 12.5% (add 2% EC & 10% SC) resulting in 14.025% for individual investors vis-à-vis interest on deposits and corporate bonds, which is charged at a marginal income tax rate, mutual funds give better post-tax returns. Are FMP returns assured? FMPs produce predictable returns over the desired timeframe since the maturity of the portfolio matches the tenure of fund schemes. Unlike other schemes that suffer from volatility and, hence, risk of erosion in asset value, an FMP – structured as closed-end funds – carries no interest rate risk. Whether yields rise or fall, the asset value of these schemes is protected as deposits / bonds are held to maturity. Availability & Loads? FMPs, being close-ended, are available for investment only during their initial offering. They are available at the face value of Rs 10 per unit. These schemes don’t levy any entry load. Minimum investment normally is just Rs 5000/-. Is premature withdrawal allowed? Yes. Exit Load will be levied on prevailing NAV. Do NAVs move sharply? No. This is a debt product. Debt product NAVs move up / down as per the movement of interest rates and changes in credit ratings of the underlying securities, and it also might go up if it’s favorable during the term of the scheme. And if you stay till maturity of 90 days / 366 days / 24 months etc as per the scheme term, you need not even look at its everyday NAV. Just treat it like a fixed deposit. Do some FMPs have equity component? It will be mentioned clearly if they are going to invest some part in equity. Normally, short duration FMPs don’t invest in equities at all. When the term is 3-5 years, some FMPs may have exposure to equity, which will be clearly mentioned. But is there something smarter in Debt for some specific needs? F-12

Page 5

Fixed Maturity Plans Situation A: You have to park your funds for short duration, but you are not sure whether you would need it back in a month or 6 months. Problem: In Bank FDs. if you make 15 days FD and renew every 15 days, you will lose on the interest rate. If you make a 6 month bank FD and if you have to prematurely withdraw it, you pay 0.50% penalty on the applicable interest rate for that period of deposit. In FMPs, if you have to prematurely withdraw it, you pay an exit load. Solution: In such scenario, where you may need your funds back at short notice, Liquid funds should be preferred over bank FDs & FMPs. Liquid funds have no specific term and can be withdrawn anytime. They generate around 5.00% p.a. returns. Opt for dividend option (monthly) so that your returns are tax-free (though 14.025% DDT is applicable) rather than paying short term capital gains tax for any period less than 1 year. Situation B: Want to invest, but No FMPs are available. Then what is a better returns option visà-vis bank FD. Solution: Check out if any ‘AAA’ rated company FDs are offering better rates than bank FDs. Currently ‘ICICI Home Finance Co. Ltd’ (Care AAA) is offering 8.50% p.a. for 37 months and for senior citizens its 9.00%. Check out for similar options.

Advantages Fixed maturity plans are income schemes of mutual funds which if held till maturity practically guarantee protection of your capital - and yet offer higher returns and superior tax advantages than bank do FDs. The secret of their higher returns lies in the fact that FMPs invest their corpus in corporate bonds, government securities, and money market instruments, etc., which enable them to earn higher returns than bank FD rates for similar periods. Capital protection advantage Typically, income funds are prone to "interest rate risk". Interest rates and prices of fixed income instruments, including income funds, share an inverse relationship. In simple words, when F-12

Page 6

Fixed Maturity Plans interest rates in the economy rise, the NAV of an income fund falls, and vice versa. This, in turn, leads to a possible capital "loss" if you exit from an income fund in times of rising interest rates. FMPs effectively eliminate this interest rate risk by investing in instruments whose maturity coincides with the end of the FMP. So a 90-day FMP will invest in instruments maturing after 90 days, and so on. Thus, the fund manager of an FMP knows what the returns the scheme is going to yield. Holding the underlying instruments till their maturity effectively eliminates interest rate risk, as the value of the instruments at their redemption is known upfront. However, though the return from an FMP is known in advance, these are not to be confused with the erstwhile assured return schemes, which SEBI has since banned. The tax advantage An FMP offers the advantage of lower tax in comparison to a bank FD. The dividend from any scheme of any mutual fund is tax-free in the hands of the investor. However, FMP being a debt-based scheme, the mutual fund has to pay the dividend distribution tax @14.165 per cent. While bank interest does not incur this dividend distribution tax but the interest is fully taxable in the investor's hands. Thus, dividend received by an individual from an FMP is effectively taxed at only 14.165 per cent as against a tax of 20.6 per cent, or 30.9 per cent or 33.99 per cent on bank interest depending upon your tax bracket. The tax advantage over bank FDs grows very marked if you opt for the growth option and a maturity of longer than a year. Upon maturity, the gains from the FMP, which you've held for more than a year, will qualify as long term capital gains. Now, FMPs being income funds long-term capital gains from them would be taxed at the lower of 10 per cent without cost indexation, or 20 per cent with cost indexation. At 10 per cent tax, the post-tax gains from FMPs will obviously be much more handsome than the interest from bank FDs which will be taxed at up to 33.99 per cent depending the income tax rate relevant to you. What is indexation benefit? F-12

Page 7

Fixed Maturity Plans The finance minister has been generous enough to recognize that inflation erodes the real value of any investment. So every year, he comes out with an inflation index based on the prevailing rate of inflation. The cost of investment is indexed by multiplying the index of the year of maturity and divided by the inflation index prevailing on the year of investment. If you have arrived at an indexed cost, then the long-term capital gain is taxed at 22.44 per cent and if you do not opt for the indexed cost, then the tax is 11.22 per cent. Take an example of a 30-month FMP which, if launched now, will mature in June 2009. It will pass through three financial years - launch in 2006-2007 and maturing in 2008-2009. Thus, it can have a benefit of triple-cost indexation for the purpose of calculating post-tax yield. Look at the workings: Note: Cost Inflation Index for FY06-07 is 519. The assumption is that the CII for FY07-08 is 567 and for FY08-09 are 592. Clearly, the post-tax return is superior for an FMP. Simran was convinced of its benefits and was gung-ho about investing in it. •

Index cost = Y * index cost of the year of maturity / inflation index of that year Bank

Fixed 30 Month FMP

Deposit With Indexation

Without Indexation

of 10000

10000

10000

Investment (Rs.) Post Expenses Yield 8.30%

8.30%

8.30%

(p.a)* Tenor (in months)

30

30

30

Approx

12,075

Amount

Maturity

12,075

12,075

Amt Gain

2075

2075

2075

Indexed Cost

NA

11,406

NIL

F-12

Page 8

Fixed Maturity Plans Indexed Gain

NA

669

NA

Tax Rate

33.66%

22.44%

11.22%

Tax

698

150

232

Post Tax Gain

1377

1925

1843

Tax 5.5%

7.7%

7.3%

Approx

Post

Annualized Return

Problems Occurring in FMP Are FMPs safe? As a product category, FMPs are very good instruments for parking your short-term surpluses, provided prudent investment choices are made by the fund managers. “FMPs are good instruments for people who want to save tax and also get good returns,” says Veer Sardesai, a Pune-based financial planner. Higher returns, better tax treatment: so where is the problem? Well, the problem lies in disclosure norms. The market regulator, Securities and Exchange Board of India (Sebi), has not made it mandatory for AMCs to disclose the portfolio and details of underlying securities while selling an FMP. AMCs have taken advantage of this fact. To lure more investors with higher indicative yields and to boast of higher AUMs, some AMCs have resorted to malpractices like allowing mismatches in maturity period (between FMPs and their underlying securities) and have also compromised on the credit quality of securities these FMPs invest in. Maturity mismatch: With growing interest of retail and corporate investors in FMPs, and the avalanche of funds that followed, a few fund houses started investing in papers whose maturity F-12

Page 9

Fixed Maturity Plans period was different from that of the FMP. Say, for instance, a three-month FMP invested in oneyear paper. (A one-year paper will give one percentage point higher yield than a three-month paper). This is known as maturity mismatch. By doing so, an AMC is taking a call on one, liquidity. At the time of redemption of the three-month FMP, the mutual fund house could be hard put to find the funds for paying off the investors because the fund has invested in highermaturity securities. And two, the AMC also courts interest-rate risk. If in the interim, interest rates rise, the value of the longer-duration bond would decline. If, under redemption pressures, the fund house is forced to sell off the bond before maturity, it will incur a loss. Compromise on credit quality: To offer higher yields, AMCs also started compromising on the credit quality of the underlying debt paper they invested in. Real estate firms and NBFCs, which are starved for liquidity, offered to pay higher interest rates to AMCs. However, the inability of some of these borrowers to live up to their repayment commitments invited trouble for some AMCs. In fact, real estate companies have offered interest rates as high as 22-24 per cent on debt raised from mutual funds. What should you watch out for? First, be aware of the risks. The returns on FMPs are indicative, not assured, as is the case with fixed deposits. Second, be prudent in your choice of investment. Resort to competent advice; say from a financial planner, while investing in an FMP. In the absence of such advice, check out the following while investing. One, always buy such products from a reputed fund house. Two, don’t get swayed by offers of higher returns. “FMPs can give a higher yield mainly by dropping the credit quality of the paper they invest in. If one FMP is offering higher yield than the rest, then it is probably compromising on the credit quality of the paper. Investors should be wary if someone is offering a higher rate compared with peers,” says Sardesai.

F-12

Page 10

Fixed Maturity Plans Three, although it is not mandatory for an AMC to disclose the indicative portfolio, always ask for one before investing. Since the portfolio is merely an indicative list, ask the AMC if there will be any major change in the list. Four, look at the credit ratings of the companies whose debt securities the FMP invests in. Make sure that the companies have been rated by an established credit rating agency and not by an unknown name, as is happening nowadays. Strengthen regulation FMPs are designed to provide steady returns in volatile markets by investing in rated debt instruments. However, laxity in regulation and malpractices by AMCs created panic last month. A few AMCs were unable to honor their commitments when cash-strapped corporate and high net worth investors sought redemption from FMPs before their maturity period. With a few regulations in place, FMPs can work better. First and foremost, strict portfolio disclosure norms need to be put in place. Sebi should make it mandatory for a fund house to disclose its tentative portfolio to the investor. “In the interest of investors, market regulator Sebi should ensure that the portfolio is well disclosed and written in a reader-friendly way,” says U.K. Sinha, chief executive officer, UTI Mutual Fund. Mismatch in maturity between FMPs and their underlying securities should also be checked. There are some companies that publish their portfolios in the fact sheet. But experts feel that publishing the names of companies is not enough. AMCs should also mention the maturity period of the underlying asset, so that an investor is aware of maturity mismatches, if any. Sebi should also ensure that AMCs invest only in high-quality debt paper that have good credit rating — and that too from established rating agencies. Lastly, bifurcated data on investments made by corporate and retail investors should be available.

F-12

Page 11

Fixed Maturity Plans

Sebi Drafting norms for FMP Fixed Maturity Plans are the much talked issue nowadays and one can see article on FMP’s every second day in all the financial newspapers. SEBI is keeping a very close eye on the working of these FMP’s.

CURRENT SCENARIO: SEBI’s Guidelines: –

Exit Load up to 6% : SEBI has said that the exit load can go up to 6% to put a check on pre maturity redemption of FMP’s Exit Load is always calculated on NAV E.g.: If an individual invest Rs. 10000 for 3 years and he wants his money back after 1 year then he has to pay an exit load which may vary from 2% to 6%.

–

Recession & Liquidity Crisis: As the global economy is in recession there is a huge crisis of liquidity in the market. All the investors are withdrawing their money from the market due to this liquidity problem. Even, the High Net Investors who has the huge investments in these FMP”s have withdrawn their money which has a huge impact on the retail investors who too are withdrawing from these plans. Due to redemption before maturity, the crisis of liquidity increases as the Fund House has to return the money back to the investors before time.

F-12

Page 12

Fixed Maturity Plans SEBI has suggested increasing the Exit Load, so as to put a check on these early redemptions.

NAV Problem: Crisil rates every bond and gives it a rating. If Crisil gives a rating of ‘A’ to any bond and its interest rate is 12%. SEBI says the rate can vary up to 200 bps, but Crisil says it can vary up to 50 bps. So the Fund Houses issue the plans at 10.50%, 11.00% 0r 11.50%. Issuing plans at different rates to different investors raises the problem in the calculation of NAV. There is no uniformity in the calculation of NAV. Therefore, SEBI has suggested that issuing plans at different rates is not a problem, but the Fund Houses should derive a uniform formula to calculate the NAV. Markets regulator Sebi has decided to put on hold clearances of new fund offers by closed-end debt funds, popularly known as fixed-maturity plans (FMPs). The market regulator is working with the mutual fund industry to come up with new guidelines for FMPs. The new regulations would include a lock-in period to correct any asset-liability mismatch. Sebi is also expected to direct funds to use the secondary market to raise resources for these funds by floating them on stock exchanges. Under normal circumstances, FMPs compete with bank fixed deposits to provide higher returns and a better tax deal. While on FDs, investors had to pay tax at the applicable marginal rate, but it’s a flat 10%; on FMPs for investments over a year. These plans basically invest in debt paper expected to mature after a year. Problems arise as investors usually make periodic redemptions way before maturity. Usually, a new fund’s inflows balance out redemptions. But the market meltdown from September has made inflows scarce but redemptions have spiked. High net-worth individuals and corporate treasuries have exited debt-related funds. MF houses have borrowed heavily from the markets and even sold investments to meet redemptions, leaving the net asset value of FMPs in tatters. F-12

Page 13

Fixed Maturity Plans Ending widespread speculation, the Securities and Exchange Board of India (Sebi) today confirmed that it will make early withdrawals from Fixed Maturity Plans (FMPs) tougher, a move that is expected to solve mutual funds’ liquidity problems. At present, investors can exit FMPs by paying 2 per cent of the net asset value (NAV) at any point of time. Sebi sources confirmed that new FMP schemes will have clauses that make withdrawals before maturity difficult. Market experts said this would imply that the new FMPs will have to be listed on the stock exchanges. This is because it is mandatory that schemes without exit options have to be listed. And investors who wish to exit will do so by selling their units at a discount. FMPs faced severe redemption pressures in October, a month which saw the Bombay Stock Exchange’s benchmark Sensex fall a record 23 per cent. According to October-end data, the average assets under management (AAUM) of FMPs stood at Rs 127,080 crore, down Rs 10,718 crore in a single month. Over 25 per cent of the entire AAUM of the mutual fund industry is in this one product. “Fund houses will benefit from this move because they will not have to bear the brunt of redemption pressures,” said a fund manager. Sebi had sought FMP data from fund houses last month on their investment and redemption patterns. There are also expectations that the market regulator would limit exposure to a single sector. Earlier, there was news that some funds were forced to roll over their schemes because some companies, especially in the realty and non-banking financial companies (NBFCs), had defaulted on their commitments. According to fund managers, Sebi is seeking to put a regulatory framework in place for these products. Investors said such a move could make FMPs unattractive because it will make them less liquid. In the past three years, FMPs were doing fairly well because the interest rate was on the rise. Some schemes were even offering up to 12 per cent last month.

FMP rating under spotlight F-12

Page 14

Fixed Maturity Plans The rating of money market funds and fixed-maturity plans by credit rating agencies could emerge as another trouble spot at a time when financial markets are swinging sharply. That’s because these agencies issue short-term ratings. These can be mfA1 by Icra or P1 by Crisil (equivalent to triple-A grade for long-term debt paper). Banks and mutual funds, in turn, conveniently use these ratings to sell their plans. The problem is that top-grade ratings for such paper apply for only a three-month period. But fixed-maturity plans usually claim the rating for the lifetime, which can be 12 months or more. In the present market conditions, the equivalence of a three-month rating to triple-A grade has started breaking down. The investment portfolios of many of these fixed maturity plans are up for downgrade by rating agencies, and that will leave investors in a tight spot. This again puts the spotlight on rating agencies, which are facing regulators’ ire around the world. Of course, the agencies say fund ratings should be read in conjunction with the volatility rating of these funds. “A fund might be rated triple-A, but you may not get Rs 100 back for Rs 100 invested. This can happen due to interest rate volatility,” says Amit Tandon, MD, Fitch Ratings, which rates a number of money market mutual funds, including that of LIC, IDFC and Benchmark. “Volatility ratings help explains the market risk of a product,” he adds. They could also be pointers to a larger problem: companies and consumers, many of whom bought these units assuming they are triple-A rated might not even been aware of the downgrades. Liquid and liquid-plus funds or money market funds accounted for a quarter of the Rs 3,60,000 crore assets under management in debt funds at August end, according to Association of Mutual Fund Industry data. The total assets under management of debt and equity funds dropped by 3% to Rs 5, 29,122 crore by September end. Though the rating of mutual funds is voluntary, nearly a third of the total portfolio is rated by agencies like Crisil and Icra. This means about Rs 27,000 crore of the liquid and liquid-plus funds currently rated potentially face downgrades. “So far, we have not seen widespread downgrades, but there is growing concern of deterioration in the credit quality of mutual funds portfolios,” said Icra Ltd managing director Naresh Takkar. F-12

Page 15

Fixed Maturity Plans Takkar says liquid funds and fixed-maturity plans are structurally flawed since they are mostly invested in long-term corporate paper, but have to ensure same-day liquidity in case of redemption. Their problem becomes severe when redemption pressure mounts, leading to massive erosion in the value of the portfolio, he said. Liquid-plus funds typically invest in debt instruments of oneto three-month maturity, whereas liquid funds buy debt products of one- to seven-day maturity. RBI has opened a special 14-day repo window of Rs 20,000 crore, whereby banks can borrow for onward lending to mutual funds. Up to Thursday, banks borrowed Rs 5,970 crore from this facility. RBI also lowered the SLR of banks by 50 basis points to enable them to lend to mutual funds. Redemption pressures on money market funds first started in the US after the collapse of Lehman Brothers, the net asset value impairment of the Reserve Primary Fund (which had significant Lehman exposure) and the temporary closure of Putnam Prime Money Market Fund. This has raised questions about the way money market fund portfolios are managed to ensure same-day liquidity and stable NAV, Fitch Ratings wrote in a note in October.

Example ICICI Prudential FMP Series 48 - 3 Years Plan B Indexation Benefit Available! Opens on: 03rd November'08 Closes on: 05th December'08 Type of scheme A Close-Ended Debt Fund New fund offer Rs.10/- per units price Allotment Date Maturity Date Tenor of the scheme

12th December, 2008 12th December, 2011 1095 days

Indicative Yield

Retail Plan: 10 to 10.50% Institutional Plan: 10.50 to 11%

F-12

Page 16

Fixed Maturity Plans Entry Load Exit Load

Nil. If the amount sought to be redeemed is invested for a period of one year Or less than one year from the date of allotment: 3% If the amount sought to be redeemed is invested for a period of more than one year from the date of allotment but redeemed before the date of maturity of the Scheme: 2%

Minimum

application Retail Plan: Rs.5,000/-

amount Investment objective

Institutional Option: Rs.25,00,000/To seek to generate returns by investing in a portfolio of fixed income securities/ debt instruments normally maturing in line with the time profile of the Plan.

The Example mentioned is the ICICI Prudential FMP Series. It’s a 3 Year Plan. The type of scheme is a close- ended scheme and its debts in nature. Debts like Commercial papers, certificate of deposits etc. The fund offered price is 10 Rs per unit and the allotment date is 12th December 2008, and the maturity date is 12th December, 2011. The statement clearly states that the time duration is of 3 years and after 3 years on the date mentioned above the FMP will expired or gets matured. The Tenor of the Scheme is for 1095 days. Indicative Plan includes Retail plan and Institutional Plan. Retail Plan is for the common people ; investments in small amount of money not in bulk whereas the Institutional Plan is for those who are investing in huge or a bulk sum of money like Investments companies such as MORGAN STANLEY,GOLDMAN SACHS etc. Hedge funds and investments sector comes under the Institutional sector. The entry load in the above FMP plan is NIL. The exit load is if the amount sought to be redeemed is invested for a period of one year or less than one year from the date of allotment: 3%. If the amount sought to be redeemed is invested for a period of more than one year from the date of allotment but redeemed before the date of maturity of the Scheme: 2% For instance; if a person invest Rs 10000 on 14 November 2008 and the FMP is for 3 years i.e. till 2011 maturity period , but in-between if the person withdraws money in the year 2009 F-12

Page 17

Fixed Maturity Plans November i.e. after a year then 3% will be charged on the rate which is till date. i.e. Rs 10000 invested but for a year it reached 10500 then 3% will be charged on Rs 10500 and same if the person withdraws after a year or so then 2% will be charged on the current rate. The minimum application amount for Retail Plan is Rs 5000 and the Institutional plan is Rs 2500000 in the above FMP , but on the other hand depends on bank to bank and as well on FMP selected by the investors accordingly rates are charged . The basic Investment Objective is that if the investor is depositing some money in the FMP and the bank is using that securities for its further benefits , the bank should keep in mind about the maturity timings of the investor so as when the investors needs money , he or she should receive money timely instead of getting delayed. The banks should have funds sufficient to repay the investors if the further investment done by bank in any of company goes default. The bank should be financially sound to repay the investors although if the investments done by bank goes wrong or default.

F-12

Page 18

Fixed Maturity Plans

Bibliography www.economictimes.indiatimes.com www.financialexpress.com www.businessstandard.com www.moneyvontrol.com www.fixedmaturityplans.com

F-12

Page 19