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Home > Business > Special

Why Fixed Maturity Plans are good

Amita Shah | April 16, 2007

The first quarter of 2007 has seen a new trend in mutual fund activity. This is mainly because a new product called Fixed Maturity Plan has garnered the maximum amount of funds. As far as figures go, during this period Rs 21,000 crore (Rs 210 billion) have been invested in more than 200 FMPs of different tenures.

In March 2007, Reliance Mutual fund alone launched seven FMPs and mobilised Rs 4,000 crore (Rs 40 billion), which helped them to attain the number one status, in terms of assets under management.

FMPs are basically debt-based products, which come with a pre-specified tenure. In a way they are similar to bank deposits but with one difference. The rate of return in a FMP is 'indicated' as against 'guaranteed' in a deposit.

However, what makes FMPs interesting is the way it is taxed. In FMPs, one has to pay 11.33 per cent (10 per cent plus surcharge) as long-term capital gains tax, if the holding period is more then one year without indexation. If indexation benefits are availed then they are taxed at 22.66 per cent.

Operationally, an FMP works this way. Say, you invest in a 91-day FMP. On allotment, you are given units of the scheme without the deduction of any entry load. After 91 days, the units are automatically redeemed and the payout is credited to your bank account without any exit load. The only criticism to this has been that there is no roll-over facility in case of FMPs.

To address this, asset management companies have come up with the concept of an  'interval fund'. The interval period can be of one month, three months and other tenures. The main differentiator in an interval fund is that there is an  option of redemption on specified transaction dates that is, the interval date with no exit load.

If you redeem in between the two specified transaction dates, then you have to bear the exit load. If you want your monies on the transaction date then you have to exercise the option or it will automatically roll over to the next interval. The indicative return on every roll over will be communicated and will vary.  In short, on a specified date, in an interval fund, there is automatic roll-over while in a normal FMP there is  redemption.

Another edge is the advantage of  long-term capital gains if you have stayed invested for more than a year.  Since the tax rate on long-term capital gains is lower, the post-tax returns are higher.

Now comes the question of dividend option. The asset management company has to deduct dividend distribution tax at a specified rate which is as follows -

Now comes the tricky part. The Finance Minister in 2007-08 Budget has increased the rate of DDT for all liquid schemes to 25 per cent plus surcharge. There is some confusion on whether FMP can be classified under the liquid category.

But as of now a couple of asset management companies have taken a view that FMPs are non-liquid schemes and they shall deduct DDT as per the table above.

But  if the tax department takes a view that FMPs are liquid schemes then the DDT rate will be 28.33 per cent.(25 per cent base rate+10% surcharge+3%education cess).

In any case 28.33 per cent is lower then the highest tax rate. So if you pay tax as per the  highest slab and are not rolling over your investment , dividend is a good option.

The advantage of interval funds is that it empowers the fund manager to take a longer term view and give superior returns by managing the portfolio duration.  At present, HDFC and Reliance have already launched and closed their Interval NFO's. If it gains acceptance considering its utility, more will follow suit.

The writer is Head - Mutual funds, Derivium Capital & Securities.

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