FMPs get attractive as rates move higherFMPs of fixed maturity plans are close ended debt schemes which invest in debt securities that are in line with the maturity of the scheme. Rising interest rates have pushed up the yields on the bonds that FMPs invest in, making them increasingly attractive.

Credit Risk Potential

FMPs can earn higher returns by investing in high yielding, lower rated bonds. Typically FMPs stick to AAA rated NCDs (Non-convertible Debentures). However many recently launched FMPs have started shifting to AA and A rated NCDs in their target portfolio. The yield (effective interest rate) on such NCDs is higher than corresponding Bank FD rates that are in the 6.5-7.5% range.

Note that FD rates are guaranteed by the bank while FMP returns are not. However, FMPs carry a lower risk than say, balanced or equity mutual funds.

You can get an overall picture of FMP yields from the yields on the Crisil indices for bonds of different categories:

Index Average Yield-to-Maturity (1st June 2018) Average Yield-to-Maturity (3rd April 2018)
Crisil Composite Bond Fund Index 8.48% 7.85%
Crisil AAA Short-Term Bond Index 8.46% 7.61%
Crisil AA Short-Term Bond Index 8.97% 8.08%
Crisil A Short-Term Bond Index 10.88% 10.07%

The Tax Advantage

Investing in FMPs is also more tax efficient than directly buying taxable bonds or NCDs. FMPs typically have a maturity of 3-4 years which brings them under the ambit of long-term capital gains tax. This means a tax rate of 20% and the benefit of indexation (which reduces tax liability to account for inflation). FMPs launched towards the end of a financial year often straddle four instead of three financial years and get the benefit of one additional year of indexation.  

On the other hand, the interest paid on NCDs/taxable bonds is taxed as per slab rate. The interest on fixed deposits is also taxable as per slab rate and TDS is deducted on them.

Note however that choosing the dividend option in an FMP will attract dividend distribution tax and will have very little tax advantage against FDs/NCDs. The effective dividend distribution tax (including cess etc) is about 29%, close to the highest slab of 30%. 

Author
Neil Borate

Neil Borate is Deputy Editor, RupeeIQ. He can be contacted at neil@rupeeiq.com.