With equity and bond funds turning increasingly volatile in the last few months, investors are flocking to fixed-maturity plans (FMPs). And, mutual funds are selling more FMPs, as corporate bond yields have increased and investor appetite for stable fixed-income products is on the rise.
Yields on AAA-rated corporate bond yields are currently hovering around 10.25 per cent; those on certificates of deposits, etc, could rise to 10.5 per cent on a bad day. A typical FMP launched during these times can lock in at these high rates.
It is, therefore, of little surprise that fixed-income investors are rushing to lap up FMP offerings. Last month, fund houses collected Rs 9,866 crore from FMPs, against Rs 3,687 crore in June, according to data from Value Research. In May, when bond yields stood at 8.5 per cent, FMPs mopped up Rs 1,798 crore.
The shift to low volatility fixed-income products is obvious: Bond funds have given negative returns in the last few months and saddled investors with huge mark-to-market losses. Shankar Raman, head (investment products and advisory services), Centrum Wealth Management, says, "The demand for FMPs is very high, as there is fear of investing in a normal bond fund. People just couldn't come to terms with the fact that even in debt (funds), you could lose money…hence, a shift to FMPs."
A new FMP generates higher returns, as it invests in corporate bonds at current yields. Also, it is stable - it doesn't have any mark-to-market loss, as FMPs hold these bonds till maturity. Open-end bond funds have to value their bond holdings at current market prices, which hit them when interest rates rise.
Now, both retail and corporate investors are looking at FMPs to lock their returns at the current high yields. R Sivakumar, head (fixed income), Axis Mutual Fund, says, "Corporate bonds are fetching excellent yields now, and this looks like a good time to invest in FMPs."
FMPs are target-date funds that buy bonds to be redeemed within a specific period. These offer maturity periods of a month, six months, one year or two years and invest in corporate bonds, commercial paper and certificates of deposits that mature around these time periods. For instance, a one-year FMP would buy corporate bonds and other papers that mature in a year.
FMP returns are locked in to a yield, as fund managers hold on to investors for the entire tenure of the fund. FMPs are not marked-to-market on a daily basis. Therefore, investors don't witness the volatility in returns seen in a typical bond or income fund. Bond fund net asset values fall when rates rise, and vice versa. Sivakumar says, "FMPs are fixed-return products, much like a fixed deposit, and intermediate returns do not fluctuate."
In the case of FMPs, investors also benefit from a tax advantage. An FMP maturing after a year is taxed as long-term capital gains, with an indexation benefit in the growth option. This makes FMPs extremely attractive for investors in the highest tax bracket.