Buy fixed maturity plans only to lock in yields when interest rates peak

Open-ended debt funds, with their liquidity advantage, should be preferred in other circumstances

Fixed maturity plans (FMPs) have been in the news in recent times due to leading fund houses like Kotak Mutual Fund (MF) and HDFC MF, which had exposure to the troubled Essel Group papers, facing issues at the time of redemption. 

The decision by Kotak MF to redeem partially and by HDFC MF to roll over its FMP created controversy. These events also led to investors asking if they should invest in FMPs at all, or whether they should stick to open-ended debt funds. FMPs have fixed tenures, ranging from one month to five years. An investor in an FMP new fund offer gets locked in till maturity. 

An FMP can have concentration risk. “Owing to the short investment window and the need to match the maturity of the underlying papers with that of the scheme, an FMP portfolio could become more concentrated than those of open-ended debt funds. In the latter, the typical holding of a security does not exceed 2-3 per cent,” says Devang Kakkad, head of research, Equirus Wealth Management.

Managers of open-ended debt funds enjoy greater flexibility. “Deployment happens on an ongoing basis, allowing the fund manager to time his investment according to the interest-rate cycle,” says S Sridharan, head of financial planning, Wealth Ladder Investment Advisers.

FMPs are illiquid products, while investors can enter and exit open-ended funds anytime. “Invest in FMPs with a view to holding them till maturity, as liquidity on the exchanges is low or non-existent. Investors comfortable with some degree of volatility should consider open-ended funds after rigorous evaluation of the portfolio,” says Kakkad.

FMPs score on the interest-rate risk front. “The interest-rate risk gets virtually eliminated in FMPs, as the securities are held till maturity,” says Jason Monteiro, AVP, mutual fund research and content, Prabhudas Lilladher. 

Credit risk affects both open-ended funds and FMPs. If a scheme invests in low-rated papers, the risk of default is higher. “In over 90 per cent of FMPs, the top five holdings account for over 45 per cent of the total asset. In 72 per cent of the schemes, top three holdings account for over 30 per cent of the portfolio, signifying there is over 10 per cent exposure to each of the top three securities,” Monteiro says.

In the light of recent events, opt for an FMP only when essential. “FMPs are attractive when interest rates have peaked and are expected to decline in future. Investors can lock in attractive yields for the investment period by investing in FMPs,” says Kakkad. 

Given their liquidity advantage, investors with some tolerance for volatility should go with open-ended debt funds. Those with low tolerance should go for very short tenure open-ended debt funds.

Open-ended debt funds versus FMP

Open-end debt MF

• Liquid in nature
• Volatile as NAV drops when rates rise 
• If he foresees default risk, fund manager can exit even if he has to take a loss.  Investor too can exit. 
• Open for investors to purchase at all times.
• Low concentration risk. Exposure to a single company does not usually exceed 2-3%. Damage is less in case of default

FMP

• Investor gets locked in for specific tenure (liquidity on exchanges is low)
• NAV drops when rates rise but investor not affected due to lock-in 
• Neither fund manager nor investor can do anything.
• Open for entry only during NFO 
• Exposure to a single company’s paper can be above 20%. Default can result in big hit to portfolio