How you can make the best of a Fixed Maturity Plan (FMP)…

Among the various schemes floated by mutual funds, the Fixed Maturity Plan (FMP) has become quite popular among investors who are looking at above-average returns without the risk of maturity mismatch. Let us look at how you can make the best use of an FMP in your investment portfolio…

So, what exactly is an FMP all about?

An FMP, as the name suggests, is a closed-ended plan with a fixed tenure. So you can have a 3-month FMP, 12-month FMP, 13-month FMP etc. What is special about this FMP is that since they are closed ended schemes, the maturity of the underlying assets held by the FMP is equal to or less than the maturity of the FMP. The FMP will invest in commercial paper (CP), certificates of deposit (CD) and also in corporate debt. What is critical is that the typical maturity of all these instruments held by the FMP will be less than or equal to the tenure of the FMP. Being a closed-ended scheme, it does not permit free entry and exit. The entry into these FMPs is open for a fixed period of time and then you can only exit at the time of redemption. So what exactly are the advantages of an FMP and why have they become so popular?

An FMP helps you overcome the interest rate risk…

Let us first understand the concept of interest rate risk a little better. The interest rate risk arises from the fact that bond prices are highly vulnerable to changes in the interest rates in the market. If the interest rates go up then the market value of the bond falls and conversely if the interest rates are cut then the market value of the bonds go up. FMP overcomes the interest rate risk by matching the maturity of its underlying assets with the maturity of the FMP. Thus the FMP locks in the yield on the date of investment and realizes the yield on the date of maturity. The FMP is, therefore, largely immune to any changes in the interest rates. This becomes a major advantage for those investors who have committed payouts after a fixed tenure. The FMP helps them earn yield on their monies and also meet their obligations with certainty.

FMPs help you reduce your overall debt portfolio risk…

The reason most debt funds give near-similar returns is that most of them are exposed to G-Secs where the scope for outperformance is quite limited. FMPs overcome this problem in two ways. Firstly, by adding CP, CD and corporate debt of high quality, the FMP manages to enhance your returns. However, it needs to be remembered that the FMP will not and should not go too much down the credit curve. This diversification also ensures that the portfolio is not overly dependent on just one debt class. This is very important since most investors in FMP try to match their obligations horizon with the maturity of the FMP. To that extent, it becomes a quasi-assured return scheme for most investors.

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