FMPs up indicative returns to 11%

With the equity markets on a downslide, mutual funds have been aggressively launching fixed maturity plans (FMPs) to attract customers. The lure: good returns and tax benefits.

Returns have been increasing steadily because of tighter liquidity conditions. Just a year ago, in September 2007, three-month FMPs’ indicative rates (mutual funds can only indicate and not guarantee returns) were around 8-8.3 per cent, and for over 12 months, they were hovering around 9-9.50 per cent. The FMPs launched this month are offering 11 per cent for both the short and long term.

For instance, SBI Mutual Fund, which raised Rs 500 crore this week, offered returns of 11 per cent for their 370-day plan. Also, for their 90-day FMP, they offered similar indicative returns, making both the plans more attractive than fixed deposits (FDs). ICICI Bank and State Bank of India are offering 6.25 and 7 per cent respectively for three to six month deposits.

However, before rushing in to invest in FMPs, one should remember that they are riskier compared to FDs as they invest in bonds and debentures of companies. And, if the company were to default, the mutual fund would be in a tight spot to deliver the indicative returns.

The recent hike in the rates of return is mainly due to the fact that both banks and companies are willing to offer higher rates to pick up money. “The push in the rates is nothing but a function of tight liquidity,” said Mohit Verma, chief investment officer, JM Financial.

According to Ramkumar K, head (fixed income), BNP Paribas, with the RBI hiking the cash reserve ratio (CRR) and repo rate in order to rein in inflation, the liquidity in the system has become tighter.

Also, due to the US financial crisis, foreign investors are selling their equity investments, leading to a sharp fall in the rupee. These factors have led to flight of money from the system. This has forced banks and firms to borrow at higher rates.
 

Scheme	Closing date	Indicative yield
Three months
Tata Fixed Horizon Fund – 19 Scheme F	24/9/2008	11
UTI Short Term Fixed Maturity Plan Series I - IX (90 days)	18/9/2008	11
One year
Lotus India FMP - 375 - Days Series XVII	18/9/2008	11.1
SBIMF-SDFS- 370 days	18/9/2008	11
19 months
Tata Fixed Investment Plan – 4 Scheme A	18/9/2008	11.45
24 months
BSL FTP Series BE (Birla)	22/9/2008	11
HDFC FMP 22M September 2008	22/9/2008	11.2

In terms of taxation, FMPs score over FDs. Returns from FMPs are taxed through the direct dividend tax method. “If a retail investor chooses the dividend option, they would be taxed at the rate of 10 per cent,” says Murthy Nagaraj, head (fixed income), Mirae Asset.

In the long term, FMPs get indexation benefits. That is, if the FMP is maturing in one year, the investor would be charged 10 per cent without indexation and 20 per cent with indexation. Further, if the FMP is for more than a year, the investor would get double-indexation benefits. On the other hand, returns from FDs are clubbed with the investor’s income. So, if the investor falls in the highest tax bracket, s/he will be taxed at 33.99 per cent (including surcharge and education).