Sunday, September 7, 2008


...but watch out for the credit risk

With interest rates on the higher side, thanks to a host of factors like inflation, high oil prices, etc., fixed maturity plans (FMP) are offering attractive yields. FMPs are debt mutual fund (MF) schemes that come in duration of 1-month, 3-month, 6-month or a little over than a year to around a year and 18 months. These are closed-end schemes that invest in fixed-return instruments and then stay invested in them till maturity. They usually buy into instruments that mature a few days before the FMP itself matures. Since they stay invested in their underlying instruments and do not trade (unlike active bond funds), they eliminate the interest rate risk.

Although the market regulator, the securities and exchange board of India (Sebi), has banned MFs from assuring any return, most FMPs will tell you in advance (strictly off-the-record and through MF distributors) the indicative yield. This is the yield you are most likely to earn, but you need to stay invested till maturity. 

But in a run to be ahead of competition and thereby offer a higher yield, some FMPs invest in lower-rated instruments. A lower-rated instrument will offer a higher yield to the lender (FMP; since FMPs invest their money in these instruments) to compensate the FMP for taking on added risk. In the course of my work (I am a journalist by profession, with Outlook Money - a personal finance fortnightly) , I came to know about a prominent MF whose one FMP got into trouble recently. One of the debt papers in which it had invested, defaulted. The MF's parent company - itself a major financial powerhouse in India - had to step in, I am told, and make good the shortfall. The bad debt was then transferred to another FMP and thus rolled over. 

Typically, higher the indicative yield, better is an FMP. But don't just go for high-yielding FMPs. Look also at the MF's pedigree. An FMP, if selected well, offers better and tax-efficient returns than a bank fixed deposit. And the only way to keep apprised of the latest FMPs that are open in the market, is to get in touch with your distributor.  

No comments: