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The rise and fall of FMPs
November 19, 2008 10:39 IST
Fixed maturity plans have been in the news for all the wrong reasons in recent times. Now media reports suggest that the exit option in FMPs (i.e. the option to prematurely liquidate an FMP with the fund house after bearing the exit load) will soon be discarded. In other words, investors will have to stay invested for the entire horizon.
Also, reports indicate that FMPs will be listed on stock exchanges, thereby offering an exit option to investors seeking liquidity.
For FMPs, it's been quite a journey from seemingly-innocuous, yet popular investment avenues to limelight-hogging villains.
What are FMPs?
Simply put, FMPs are close-ended debt funds with a fixed maturity horizon. They invest in debt instruments to arrive at a pre-determined yield. Fund managers target the yield by identifying certain instruments and staying invested till maturity.
As a result, the 'indicative' yield can be communicated to investors at the new fund offer stage. This in turn means that investors are aware of both the likely return they can clock and their investment horizon, factors that are typically important for a fixed income investor.
FMPs often compete with fixed deposits for a place in investors' investment portfolios. However, their investment propositions are different on several counts. For instance, FMPs offer an indicative return, while returns on FDs are assured.
Also, FMPs are equipped to offer better post-tax returns vis-�-vis FDs. This in turn adds to the allure of FMPs.
The rise and fall of FMPs
FMPs witnessed a purple patch in the 2006-07 period when bond yields were on the rise. Fund houses launched a host of FMPs, investment advisors did their bit to promote the cause of FMPs as 'assured return' investments and investors gleefully lapped up the FMPs on offer.
The fact that FMPs are market-linked investment avenues and are subject to risks like credit risk, the actual yield not matching the indicative yield, among others were all but ignored.
However, these risks were brought to the fore by changing market conditions. Factors like a slowdown in the economy and the ensuing liquidity crunch meant that the creditworthiness of some companies whose debt instruments FMPs had invested in came under the scanner.
Then there were instances of some fund houses making investments in illiquid instruments in a bid to clock higher growth.
In some cases, longer tenured instruments found place in FMPs with a shorter maturity profile. Such investment strategies were tested when liquidity dried up and investors (in a panic mode) rushed to redeem their FMPs, forcing fund houses to make distress sales. This in turn had a telling effect on the performance of FMPs, which further contributed to the panic.
The media was buzz with reports of how FMPs spelt doom for investors and terms like securitised debt, real estate and NBFC became a part of dinner table conversations. And of course, FMPs became a four letter word.
Investors would do well to understand that there is nothing wrong with FMPs as investment avenues. Most of the negativity that surrounds FMPs at present is the result of the manner in which FMPs have been managed (by some fund houses) and marketed (by a section of investment advisors/distributors); this lead to uninformed investment decisions being made by investors.
Fund houses have begun to hike the exit loads on FMPs to ensure that investors are dissuaded from making premature redemptions. Should the regulator decide to do away with the exit option in FMPs as has been reported, it could well be a positive step.
It can aid fund houses in managing FMPs as close-ended products without being concerned about redemption pressures. This in turn will also help the cause of investors who wish to be invested in FMPs for its entire horizon as they won't have to bear the brunt of a distress sale.
Also, there is a need to ensure that portfolios of FMPs be in line with those indicated at the NFO stage. Fund houses taking shelter under the disclaimer 'the portfolio is only illustrative in nature and the actual portfolio may differ materially' should become a thing of the past.
On their part, investors must take informed investment decisions. They must understand that investing in FMPs entails being invested for the entire tenure; it involves taking on a certain degree of risk and that FMPs are not assured return instruments, as they have been erroneously made out to be.
If an assured return investment is what investors seek, they should consider making investments in avenues like 'AAA' rated/bank FDs and small savings schemes.