How to get 10% return from mutual funds FMP?

by Admin on July 8, 2011 · 0 comments · Mutual Funds


How to get 10% return from mutual funds FMP?, 1.0 out of 10 based on 1 rating

Fixed maturity plans (FMP) offered by mutual funds have become fairly popular among investors in the recent past, given the fact that the stock market hasn't gone anywhere.

Also, thanks to the hardening interest rates, FMPs have started offering superior tax-adjusted returns to investors. In fact, according to investment experts, an FMP of little over a year can offer a per-tax return of close to 10%.

An FMP is a closed-ended scheme offered by a mutual fund, which matures on a certain date, ie, the scheme runs for a fixed period of time. The period of maturity can be anywhere between three months and three years. "When the fixed period comes to an end, the scheme matures and your money is paid back to you.

So, in a sense, you could consider FMPs to be fixed deposits (FDs) issued by mutual funds (MFs)," explains Sandeep Shanbhag, director, Wonderland Consultants, a tax and financial planning firm. Currently, FMPs maturing in a little over a year (usually 370 days) are the most popular ones. The money collected by FMPs is generally invested in various kinds of financial securities, like certificates of deposit (CDs) issued by banks and commercial papers (CPs) issued by other companies.

The tenure of the FMP is usually equal to the tenure of the financial securities that are invested in. The idea is to lock in the investment at a specified rate of return, thereby immunising the return against any debt market fluctuations.

CURRENT RETURNS ON FMPS

Until sometime back, mutual funds were allowed to give out indicative returns on FMPs. This gave investors an idea about the kind of returns they could expect.

The Securities and Exchange Board of India, the stock market and mutual fund regulator, has now banned the practice. However, unofficially, most mutual funds do give out indicative returns. The expected return on an FMP largely depends on the returns being offered by the financial securities they have invest in, ie, CDs and CPs.

As Suresh Sadagopan, a certified financial planner who runs Ladder 7 Financial Advisories, explains "The current returns for 90-day CDs are about 9.4% and the one-year return is around 10%. Taking into account the expenses, the pre-tax return on an FMP could be 0.2% to 0.4% less." This means, most one-year FMPs now offer around 9.6% to 9.8% return, whereas 90-day FMPs offer around 9% to 9.2%. "Returns are around 9.6% to 9.7% for an FMP fully invested in bank CDs," says Vijay Chhabria, a certified financial analyst who runs Prudent Investment Advisors.

WILL THE RETURNS GO UP?

Experts are of the view that these returns will go up in the near future as they expect the RBI to raise interest rates further to tighten the burgeoning inflation. This may increase the returns from CDs and CPs that FMPs invest in, thus pushing up FMPs' returns in turn.

"The returns are expected to go up further as there seems to be more rate tightening possible. I expect another 0.5% increase in all. The yields for one-year FMPs are already nudging towards 10%," says Sadagopan. Shanbhag expects returns to go even higher than 10%. "Inflation will be an ongoing challenge. Consequently, interest rates may need to be tightened still further. In such a scenario, one could expect returns to touch 10.5% or even 11% pa over the medium term," he says.

BETTER THAN FDS IN RETURNS

So should you be investing in FMPs when returns from fixed deposits(FDs) are also touching 10%? "What gives FMPs the edge is greater tax efficiency. In other words, on a tax-adjusted basis, the return on an FMP is higher than that of a bank FD," explains Shanbhag.

"This is because the interest on bank FDs is fully taxable whereas the return from FMPs is subject to capital gains tax (for the growth option)," he says. Capital gains made on invest-ments in FMPs for a period of more than a year are taxable at the rate of 10% without indexation, or 20% with indexation, whichever is lower. Indexation essentially takes the rate of inflation into account while calculating the cost of acquisition of an asset. This ensures that the capital gain is lower, and, hence, lower tax. Also, the current inflation, in the range of 8% to 9%, will ensure that most of the capital gains are not taxable at all. This ensures that the rate of return on an FMP is better than from a fixed deposit even if you happen to fall in the lowest tax bracket of 10.3%.

That probably explains why investors are flocking to FMPs. "Most investors who had invested in bank and company FDs a couple of years ago are in the process of liquidating the same and reinvesting the proceeds at a higher yield," says Shanbhag.

HOW SAFE ARE FMPS?

FMPs are very safe. "If an FMP is investing only in bank CDs, then there is no risk at all," feels Chhabria. "Most MFs maintain that their FMP products invest largely in bank CDs. After the past experience, financial securities issued by real estate companies are being avoided largely. However, there could always be the odd FMP which could take exposure to infrastructure and real estate paper to jack up the yields. In this respect, investors would be better off sticking to offers from pedigreed and reputed funds even if the return is marginally lesser," says Shanbhag.

DIFFICULT TO GET OUT

What investors should remember is that it is very difficult to get out of an FMP before it matures.

Earlier, if an investor wanted to come out of an FMP investment, he could redeem his investment with the mutual fund by paying an exit load of around 2% of the net asset value. Now, a mutual fund is not allowed to redeem an FMP investment.

These schemes are listed on the stock exchange and the investor can sell his units to any other investor willing to buy.

But there is no liquidity in these schemes, ie, if you are looking to sell, there are no buyers. "The liquidity is poor. I tried looking up the FMPs I have invested in on the NSE site and it said there are no trades for the securities," says Chhabria.

Given this, investors should invest in FMPs only if they do not need the money any time soon.

"Liquidity is an issue with FMPs as it depends on someone buying them from you. FMPs are not really liquid from a practical standpoint. We suggest FMPs to only those who can hold them till maturity," says Sadagopan.

Source: Economic Times

 





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