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Check out the yield and portfolio in order to cut out the risks

Equity mutual funds have traditionally been the darlings of fund houses and have always been promoted far more aggressively vis-à-vis debt funds. In fact, till recently, several investors were even unaware that mutual funds had as big a portfolio of debt investments, as they had of equity. It was a win-win for everyone - booming equity markets made a lot of money for the investor, while high commissions and expense ratios made them attractive for the asset management companies (AMCs) and distributors.

However, following the carnage in equity markets over the last few months, the AMCs have shifted their attention to debt instruments. As aggressive rate hikes by the RBI and tightening liquidity have pushed short-term bond yields higher, debt investments have become far more attractive investment propositions than they previously were. This is prompting AMCs to aggressively push debt products such as liquid funds and fixed maturity plans (FMPs).

FMPs are closed-ended funds with a fixed tenure that invest in debt instruments such as certificates of deposit, commercial paper and corporate debentures whose maturity coincides with the maturity of the fund. The tenures of FMPs range from as little as a month to as long as three years.

Ideally, investors should think of them as alternatives to keeping money idle in the savings account, or putting it in fixed deposits (FDs). They typically have no entry or exit loads, and are run on low expense ratios. Thus, today FMP yields match those of FDs, and the FMPs have added benefit of lighter taxation, as explained below. As FMPs are closed-ended in nature, they are able to lock in the yields. They invest in debt papers that mature in line with the FMP, which gives them a good idea about the yields at the time of investment. Also, any intermittent volatility due to changing interest rates is avoided as the investor is expected to remain invested till maturity. Since FMPs ideally hold papers till maturity, high interest rates tend to work in their favour as bond prices fall, thus increasing the yield to maturity. However, if an investor chooses to exit the fund prematurely, he will be exposed to interest rate risks and also be subject to an exit load. Hence, investors should invest in FMPs only if they seek the money after a specified period of time and do not have any liquidity constraint.

On the taxation front, FMPs score highly over bank fixed deposits. For investments less than one year, the dividend option is preferred, where the tax rate is 14.16%, as compared with interest on bank deposits where the tax rate could be as high as 33.99%. For tenures greater than a year, FMPs are even more attractive, with taxation in growth option at just 10%, while interest income from FDs continues to be at 33.99%.

While traditional FMPs have been selling like hot cakes, a popular variant that is fast making its presence felt is the interval fund. Interval funds usually have shorter durations and provide investors an option to continue or redeem their investments during the liquidity window. While they are superior to liquid funds in the returns comparison, they have relatively less liquidity and can be redeemed only during the liquidity window without being charged an exit load. The most popular interval funds are those in the range of one to six months. While there is little doubt that FMPs are probably the best investment propositions today, it is imperative that retail investors know about the risks involved in them. Despite being relatively safe instruments, they are still a tad riskier than bank fixed deposits as the investments made are exposed to credit or default risk. Till recently, several FMPs had exposure to real estate companies. Given the hard times facing the real estate industry, investing in such FMPs no longer looks a prudent option.

In general, therefore, it is important to study the yield and portfolio of the FMPs carefully (as contained in their key information memoranda) before investing. If chosen properly, they deliver almost four times the income of savings accounts, and 30% higher income than FDs, at almost no additional risk.