Fix it right

Since money market rates shot up a few weeks ago, fixed maturity plans (FMPs) now offer higher indicative yields. The current yields on FMPs are between 11 per cent and 12 per cent, up from around 10.5 per cent just a few months ago. Sure, it's a sign of the times as the credit crunch is pushing up interest rates. And the higher indicative yields are luring many investors to park their money in FMPs. Assets under management of FMPs have increased considerably in the last four months to Rs 1,02,133 crore currently.

Yet, when investing in FMPs, don't throw caution to the wind. FMPs, typically, buy paper that mature simultaneously, and they return the investments back to the investor when the tenure ends. This strategy helps avoid market volatility and the final realisation is largely predictable, though this depends on how well the fund manager is able to deploy his corpus. This also helps in estimating the indicative yields, though this could change when the final deployment is made.

Lately, fund houses have become aggressive in their quest for returns, and are investing in higher-yielding investments. This increases the chances of a default, particularly if the fund has invested in sectors such as real estate, where higher interest rates have increased the chances of a default. Even if, say, there's a default of 5 per cent of the corpus, then you will hardly gain anything from your FMP. In fact, in a three-month FMP, you will actually lose money.

This is not to say that all FMPs are bad. Fund houses usually disclose the asset class that they will invest in, and the tenure of FMP. If the investments are in sectors such as real estate that are likely to be impacted by the slowdown, then avoid such FMPs. On the other hand, if an FMP invests in, say, bank commercial deposits or AAA-rated paper of the manufacturing sector, then you might want to go ahead with that investment.

Unlike equity investor, investors in FMPs typically don't want to take a risk with their investments. So, don't get lured by higher interest rates. It's better to sacrifice a bit of yield, which is just about 1 per cent. Do look at the ratings of the planned portfolio before investing in an FMP. Also, assess the track record of the issuing fund house and compare how the FMPs have fared against their promises. If there's a divergence, it's better to avoid the fixed maturity plans of the fund house. Stick to shorter-tenure maturity plans for now, as they mitigate the risk of holding longterm paper. Just make sure you do your homework.

—Clifford Alvares