Choose the right tenure for your fixed maturity plans

They are giving better post-tax returns than NCDs or FDs. But get in for a year or two only.

Debt instruments have become the flavour of the season, courtesy a rising interest rate regime. Fund houses are concentrating on launching fixed maturity plans (FMPs) aggressively.

In 2009, only 90 FMPs were launched; in 2010, as many as 340. This year, in the first eight months, fund houses have launched as many as 410 schemes.

FMPs are typically debt instruments that invest in various kinds of financial securities, such as bonds issued by the government and companies, and money market instruments such as treasury bills, certificates of deposit and commercial paper.

For investors in these products, the important problem is choosing the right tenure. Dhirendra Kumar, chief executive director at Value Research Online, a mutual fund rating agency, says, “If you do not require money in the immediate future (in less than a year), it is advisable to go in for longer tenure FMPs, that is, between one and two years.” FMPs come with tenures of 15 days to five years.

Though fund houses can no longer give indicative returns of these products, one can get the approximate rate of return. FMPs maturing in one year are offering 9.25 per cent, whereas those close to two years (600 days) have been offering around seven per cent. In comparison, State Bank of India is offering 9.25 per cent for its fixed deposits (Fds) for tenures from one to 10 years. But there is a catch.

There will be a tax on the interest income on FDs. That is, for the highest income tax bracket, there will be a tax of 33 per cent, thereby bringing the rate of return down from 9.25 to around 6.47 per cent. An FMP offering the same rate of return will get double indexation benefits. The tax on the return will get two inflation indexation benefits – on the year the amount is invested and the year the amount is withdrawn. The rate of tax on returns will be 10 per cent without indexation and 20 per cent with indexation. The post-tax returns for a one-year FMP is 8.32 per cent.

There are a number of NCDs offering attractive rates. For instance, Shriram City Union and Manappuram Finance are offering over 12 per cent annually. Shriram City will return 12.1 per cent annually for four years and 11.85 per cent for three years. Manappuram will give 12 per cent per annum for 400 days and 12.20 per cent for two years.

However, due to taxation, the rate of return in the case of Shriram City and Manappuram would fall to 8.5 per cent. Plus, these instruments are less liquid because of longer tenure and riskier in nature.

Another advantage of investing in the longer term scheme at present, according to Mahendra Jajoo, executive director and chief investment officer (fixed income) at Pramerica Mutual Fund, is that the interest rate cycle is likely to peak out soon. If you were to get yourself locked into a higher paying instrument, the returns would be substantially higher.

If one does not want to get locked in at current rates, short-term FMPs (less than a year) are offering almost nine per cent. But remember to opt for the dividend option. The rate of taxation is lower at 14.16 per cent, unlike the growth option. In case of the latter, you will be taxed on the applicable slab of the investor. The growth option is a good one for those in the lower tax brackets or those not taxable.

However, remember that both non-convertible debentures and FMPs have to be listed at the exchanges. Which means in case one needs to get out in the interim, one may have to exit at a discount because of the lack of a vibrant secondary market. In the case of FDs, the exit is easier, as one can pay a small penalty and do so.