The shine is off FMPs

Go for short-term bond funds as opposed to similar tenure FMPs, but longer term advantage of the latter remains

Investors looking to park their money in fixed maturity plans (FMPs) might do well to look at short duration bond funds for now. A reduction in short-term rates, following the Reserve Bank of India (RBI)'s cut in the marginal standing facility (MSF) rate to 9.75 per cent (from 10.5 per cent), has resulted in a marginal reduction in yields for FMPs, making short-duration FMPs from a month to less than a year a tad less attractive.  

Experts say with the interest rates coming off after the credit policy, compared to August and early September, short-term fixed maturity plans are losing investor appetite to short-duration bond funds. However, longer-duration FMPs for more than a year still see some investor appetite. Says R Sivakumar, head of fixed income, Axis MF: “There's still a healthy appetite for longer-duration FMPs, given that the yields are still relatively better. We are looking at investor appetite increasing in the next few months.”

Post the RBI policy, yields on certificates of deposits have come off to around 10.5 per cent against 11 per cent and above before the RBI policy. As a result, FMPs that invest in a host of fixed-income papers such as certificates of deposits and government paper are likely to make marginally lower yields from their fixed income investments going forward, as compared to August.

FMPs saw high inflows of nearly Rs 28,800 crore in July and August as investors rushed to lock in at higher rates. The months also saw a spike in the number schemes on offer to 376, compared with 374 schemes launched in February and March, when there's a seasonal year-end rush to invest in FMPs for tax-benefits.

Capital gains in the short-term FMPs in the growth option are taxed as per the income tax slab applicable to the investor. At the lower expected yield of around 9.7 percent, the post-tax yield to investors is not quite as attractive now for investors in the highest tax bracket, say experts.

Yields on long-duration FMPs of over a year are still attractive post-tax for investors looking at a longer tenure to park their money. For, FMPs held for over a year, capital gains tax is 20.66 per cent (including surcharge) net of indexation or 10.66 per cent without indexation. On an investment in a 366-day FMP that yields around 9.5 per cent, investors are making a post-tax return of around 9.04 per cent on current yields after taking indexation benefits. In retrospect, in the months of February and March when FMP investments are at their peak post-tax returns hovered around 8.25 per cent.

However, the current relative returns are higher in a short-term bond fund as short-term interest rates are expected to come off even further on RBI easing. This could lead to marginally higher bond gains to investors in the short-end of the yield curve. Says Shankar Raman, head investment advisory services, Centrum: "Investors are looking at relative returns right now from other bond investments, and short-term bond funds are looking better from that perspective.”