Fixed-Term Plans and Who Should Invest in FTPs
Did you know that out of the total mutual fund industry AUM of Rs40 trillion, the AUM of closed-ended funds is just about Rs25,000 crore. Even within that, Fixed Term Plans (FTP) account for 66% of the total AUM of closed-ended funds. But there is a more interesting trend that is visible. If you look at the mutual fund new fund offerings (NFOs), then FTPs are playing a key role in new fund collections. If you look at the month of November 2022, out of the total NFO flows of Rs7,191 crore, closed-ended FTP flows alone accounted for Rs3,703 crore or 52% of the NFO flows. What are these FTPs and why are they attracting interest?
Fixed Term Plans (FTPs) and who should invest in FTPs
In case you are getting confused between FTP and FMP, they are one and the same. Some funds call it FTP and some call IT FMP (fixed maturity plan). These are closed-ended debt funds, where investors have to stay invested for a fixed period. The FMP invests the corpus in various interest-bearing debt securities which match the maturity of the scheme. That means, if the tenure of the FTP/FMP is 1,200 days, then the investments will be in debt with an approximate average residual maturity of 1,200 days. Hence FMPs normally generate returns very close to similar bonds with the same maturity profile. However, that does not mean this is an assured return scheme; as is popularly believed.
FTPs / FMPs are meant for investors willing to lock in their funds for a period of over 3 years since that is the typical maturity of the FTP. The big advantage of FMPs is that, since they are held to maturity and invest in similar maturity debt, the final yield is fairly predictable. This gives greater stability to returns. It is also good for investors looking to reduce their tax burden on investments, as we shall see in detail later.
Advantages of investing in FMPs
There are some distinct advantages of investing in an FMP / FTP and some of the key benefits are enumerated below.
- FTPs / FMPs minimize interest rate risk. Now, interest rate risk or price risk is the risk that the price of the bond could fall on account of a sharp rise in interest rates. It is obvious that these FMPs are least exposed to interest rate risk because the fund manager will normally hold instruments till their maturity. Also, FMPs tend to invest in securities with higher credit quality so that credit and liquidity risks are mitigated.
- Reduced churn and transaction costs is another major advantage of FTP / FMPs. Normally, debt funds try to create alpha by trading aggressively i.e., trading on maturities, durations and credit quality. In the case of FTP/FMP, the investments are made in line with the maturity of the fund. Hence, the scheme does not need continuous buying and selling of securities. This reduces the costs significantly.
- FTP / FMP is much more tax efficient than similar instruments like bank fixed deposits (FDs). This arises due to the indexation benefit in FTP/FMPs. When these funds are held for more than 36 months (remember they are debt funds), it becomes long-term capital gains and the taxable capital gains amount is reduced by indexing the gains and which is meant to give protection against inflation. Normally, the effective long-term capital gains tax on FTP reduces from 20% to below 10% due to indexation impact.
- One important point is the benefit of dual indexation available on FTP/FMPs. Being closed-ended funds, these funds are issued for specific maturities. AMCs normally launch such FTP funds in February / March with maturity in April, 3 years later. That is why you see FTPs of 1,200 days so popular. By holding a little over 3 years, the scheme straddles 4 financial years and thus gives that added indexation benefit of 4 years instead of 3 years. This reduces your tax burden even further.
Why are FTP / FMPs becoming popular of late?
If you look at the last 5 months since new fund offerings (NFOs) were permitted once again, there has been a clear bias in favour of FTPs. Here are some of the reasons for their growing popularity.
- HNI investors are looking to lock their funds up for over 3 years at attractive yields in the market. with the RBI hiking repo rates by 225 basis points since May, the bond yields have also shot up sharply in tandem. Markets are expecting, that rates should top out sooner, rather than later. Hence the FTP / FMPs offer a very good method of locking in funds at attractively high bond yields for a period of over 3 years.
- The biggest advantage in these products is the post-tax yield. Unlike bank FD interest that is treated as other income and taxed at the peak rate, the FTP/FMP is treated as long term capital gains on sale after 3 years. A combination of indexation and dual indexation makes the average post tax yield on these FTPs, around 90-100 basis points higher compare to an FD with similar pre-tax yield. That is a major driver.
To sum it up, FTP / FMPs are in a sweet spot wherein investors can lock in funds at high yields, with the added kicker of attractive post tax yields. That is what is driving this sudden surge in fixed term plans and fixed maturity plans in the Indian market. If you are interesting taking an full benefit of investing in mutual funds than you should start as soon as possible