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The dark side of Fixed Maturity Plans!

June 05, 2009 14:40 IST

You must be aware of the fact that investing in fixed maturity plans allows an investor to earn higher returns while minimising his exposure to risk. As a result, many fund houses have introduced their FMPs to entice investors. But what are FMPs? Are they safe as they seem to be? If not, what are their pitfalls? Here we answer all such questions.

What are FMPs?

FMPs stand for Fixed Maturity Plans. As the name implies, these plans have a certain maturity period. They are closed-ended funds, meaning you can invest in them only when they are open for purchase. This is only during NFO period. To redeem your investment, you need to wait for the pan to mature or pay a stiff 2 per cent exit load.

Where do FMPs invest?

The reason investors choose FMPs is for their high returns which are also guaranteed. In order to give assured returns, FMPs opt for very secure investment options like AAA rated corporate bonds whose maturity tenure matches the maturity tenure of FMP. However in the recent times, some of these FMPs started investing in commercial paper from real estate and finance companies, in order to give higher returns o their investors.

Are there any risks in investing in FMP?

Yes, definitely. Despite their claims of being one of the safest investment options around, FMPs do have their own share of risks. Here are some of them:

The yields on FMPs can vary drastically. Those FMPs offering higher yield can afford to do so by investing in risky investment options.

This has been evident in 2008, when these funds faced liquidity crisis due to their exposure to real estate and finance companies. When the finance and realty companies landed in trouble during the recent economic downturn, their offerings also lost value. With the investors pulling out their investments from these FMPS, the funds were forced to offload their investments in the illiquid markets, thereby causing liquidity crisis.

While FMPs offer safety of their capital, they do not offer protection against interest rate risk. As the interest rate rises, the value of the bonds goes down. This can affect the returns of the fund.

The yields of FMPs are just representative. The actual yield will depend on the yield on the debt instruments at the time of actually investing your money.

Do I have to follow any specific precautions?

Yes. Here are some of the precautions you must follow if you want to get the best from your FMP.

  • Check out the indicative portfolio of the fund. If you observe the presence of any securities that are not AAA rated, don't invest.
  • Don't depend on the indicative yield as the actual return. There may be a big variance between the yield shown by the fund house at the time of investment and the actual yield.
  • Always stick to the maturity period of the plan. Don't withdraw half way through as it will force the fund manager to redeem investments at any available price, thereby causing losses to you as well as other investors.

Follow these precautions and you will not have any problem with investing in FMPs.

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