FMP yields looking good again !

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The biggest advantage of investing in FMPs is the tax benefit. One can pay long term capital gains at 10 % or choose to pay 20 % after claiming indexation benefit. This year thanks to high inflation, the Cost index used to calculate capital gains will be at least 7% to 8 % higher. If that is the case then by taking the option of 20 % tax with indexation benefit, you may end up having almost all your capital gains tax free. FD interest on the other hand is taxable at the marginal rate of tax applicable to you.

For working of tax benefit refer to articile on the following link https://www.ppfas.com/pdf-docs/research/week-reports/2008/wr090808.pdf

The only real disadvantage with respect to this instrument is liquidity. You can break a bank fixed deposit if there is need for funds. The bank may pay you a lower rate of interest or charge you a nominal penalty, but you still get your money back in a day or two. FMPs on the other hand have zero liquidity. As per Sebi's order last year FMPs are now close ended funds with no exit option. In order to offer liquidity, fund houses have to compulsorily list FMPs on exchanges where they can be bought and sold by investors like any other security. This move by SEBI was primarily meant to stop the practice of early exits from FMPs by HNI and corporate investors. Due to such early exits, fund managers were forced to liquidate good quality and liquid bonds from the portfolio leaving low quality portfolio (and hence lower returns as well as higher expenses) in the hands of residual investors. Although all FMPs issued since the new guidelines came into effect are listed on the stock exchanges, there is no liquidity. Even if there were a buyer, the quotes are not very favorable and trades executed at these quotes can leave the seller with negative to very low gains. Only if you are sure that you will not need any liquidity for the entire term should you invest in a FMP.

Unlike FD's, FMPs do not offer a guaranteed rate of return. Depending upon the tenure of FMP, the Fund Manager invests in a combination of debt instruments of similar maturity. For instance, if the FMP is for a period of one year, then the investments are made in instruments of up to one year maturity so that the investments mature on or before the maturity date of the FMP. By doing this, the Fund Manager attempts to protect the yield of the portfolio and the investor can reasonably assess the likely income from the FMP at maturity based on the monthly disclosures of investment by the Scheme.

Yields from FMP come from the combined returns of securities in its portfolio. There is a possibility that one or more of the issuers default on either interest payments or the capital itself. This risk is called credit risk and though this is a rare scenario, as an investor you can protect yourself by investing in schemes where the investments are predominately in AAA or AA rated instruments. Choosing good fund houses that have experience in dealing with bonds and are conservative helps. In any case Sebi's new guidelines require strict restrictions and disclosures before launching FMPs and hence the portfolio quality is far better than in previous years.

For the long term debt investor this is a good time to invest in FMPs. Yields are looking up and post tax returns are better than any other debt instrument.

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