FMP Debt Funds: Benefits & Tax Efficiency Explained

A close-ended debt fund that invests for a specific period of time and has low risk

Investors looking for a debt exposure in their portfolio generally opt for traditional debt instruments like Bank FDs (Fixed Deposits), Bonds, NSC (National Savings Certificates), Post Office, etc. Very few investors are aware that these are not the most tax-efficient investment avenues. The income from these sources is fully taxable (except PPF and PF) and hence the real return (after tax) is often lower than the prevailing rate of inflation.

Read on to know how FMPs (Fixed Maturity Plans) can make be an ideal avenue for debt investments.

What is a FMP?

FMP (or Fixed Maturity Plan) is a closed-ended debt mutual fund. Such a fund invests only in instruments whose duration is similar to its own term i.e., it aligns its term with that of its underlying assets. For example, a 1115-Day FMP would invest in instruments that mature in 1115 days or slightly before that.

Such synchronization done to eliminate the risk of interest rate fluctuation (usually faced by debt funds).This scheme is apt for investors who seek stable returns from a debt investment.

What is in it for the investor?

Long-term FMPs (held for a period of 36 months or more) are an ideal investment avenue for investors who:

* Need capital protection

* Want to take a minimum exposure to market risk

* Wish to park funds for a long-term goal

* Wish to avail double indexation benefit

* Earn a steady return on investment

The FY-15 union budget has changed the taxation rules for non-equity mutual funds like FMPs. Accordingly, short term capital gains (one and two-year FMPs) will be taxed at 30% (assuming the investor falls into the highest tax bracket).

What does a FMP Portfolio comprise of?

The FMP invests in various debt market securities like:

* Non-Convertible Debentures(NCDs)

* Corporate/Government Bonds

* Treasury Bills (T-bills)

* Commercial Papers(CPs)

* Certificates of Deposit (CDs)

* Bank FDs and other money market instruments

How does a FMP return look vis-à-vis a Bank FD return?

The table below illustrates returns of a fixed deposit and FMP for a term of three years (assuming the investment was done in the financial year 2011-12). Remember that indexation benefits (a method of factoring inflation and reducing the amount of taxable income) are available for investors who invest in long-term FMPs. 3-year FMPs have a significant tax advantage over fixed deposits.

Note:

*** Cost Inflation Index (CII) for year of redemption (2014-15) is 1024 and year of investment (2011-12) is 785. The indexed cost of purchase = (A*1024/785)

** Highest bracket of tax rate has been taken based on current IT slabs.

* Tax rate for long-term debt assets (includes surcharge and cess)

Things to consider before selecting a FMP

Knowing where the FMP invests is extremely important because the quality of its portfolio determines the credit risk (credit worthiness of the fund's underlying assets) it is subjected to.

Read the Scheme Information Document (SID) carefully and check the past record for the FMPs of the fund house. While past performance is not a predictor of future results, it can give you a fair idea about the capabilities of the fund manager.

Do FMPs have any drawback?

FMPs cannot be easily redeemed before the maturity or final date of redemption. Investors seeking redemption before maturity have to sell the units on the stock exchange. As per guidelines, all FMP schemes are listed on the stock exchanges however; trading is rarely done on the units.

Contact us (through the Query Form on the right hand side) to know more about debt-based investments.