There is a clear preference for open-ended funds among investors, as these are adequately liquid.

There was a time when Fixed Maturity Plans (FMPs) used to be popular among investors. In particular, March was the time when this debt product used to be pushed, as it would enable another year of indexation benefit for computation of long-term capital gains tax. Over a period of time, the popularity of FMPs waned. We will discuss the reasons for this decline.

Let’s look at the numbers first.

As on March 31, 2019, the AUM (assets under management) of open-ended debt, gilt and liquid funds was Rs 9.9 lakh crore (Rs 9.9 trillion). FMPs accounted for Rs 1.7 lakh crore or 17.4 percent of open-ended debt funds’ AUM. In March 2020, open-ended debt fund AUM (average of the month) increased to Rs 11.5 lakh crore (Rs 11.5 trillion). However, the AUM of FMPs dipped to Rs 1.4 lakh crore. As a percentage, FMPs were 12.2 percent of open-ended debt fund AUM. Come March 2021, open-ended AUM rose to Rs 13.9 lakh crore (average of the month) whereas FMPs collectively managed Rs 1.2 lakh crore, representing only 8.6 percent of the open-ended debt fund AUM.

What changed the fortunes of FMPs?

Over the two years mentioned above, FMP AUM dipped from 17.4 percent of open-ended debt AUM to 8.6 percent. The reasons are as follows:

-FMPs are useful when rates are on the higher side.  Over the last two years, interest rates have eased, except for the last three months or so. With reducing interest rates, the appeal of FMPs has waned. Open-ended debt funds benefit from the mark-to-market impact when interest rates decrease. On the face of it, mark-to-market happens in FMPs also, but on maturity of the product, the initially contracted rates are realized. Since FMPs do not benefit from this aspect, interest levels of investors in the product has reduced.

-Issues with two fund houses in March 2019: Many AMCs (asset management companies) held loan-against-share (LAS) bonds/debentures of Essel group (Zee group). The group was in trouble and was not in a position to honour obligations in March 2019. Lending entities had various ways of dealing with it. Some entered into a ‘standstill’ agreement with the promoters – that they would not sell the shares before September 2019 – and the promoter committed to repay dues by that date. Two AMCs had FMPs maturing in March 2019. Kotak AMC allowed the FMPs to mature in due course and realized the disputed component by selling the shares subsequently in the market. HDFC AMC extended the maturity of the FMP and the AMC purchased the stock from the scheme. All this led to sharp discussions about the credit risk issue in FMPs, as all securities mature at the same time. This led to the lowering of the popularity of FMPs.

-Lack of liquidity: FMPs are listed on the exchange, as a rule. There is no redemption with the AMC. However, there is no liquidity in the secondary market. Once you are into it, you have to stay on till maturity. This lack of liquidity has been a feature of FMPs since 2009. When something is falling out of favour, the shortcomings get highlighted. This aspect of lack of liquidity becomes more relevant in the background of falling rates and the occurrence of credit defaults.

Which is the better option?

There is a clear preference for open-ended funds as liquidity is not sacrificed. You should invest as per your objectives and horizon and should be disciplined to hold on till the intended time period. Having said that, in case you require liquidity, you can redeem your open-ended fund holdings with the AMC. Liquidity is a relevant feature for any investment. Within open-ended funds, consider the following:

-Roll-down maturity funds: In an FMP, the residual or remaining maturity of the fund comes down every passing day and the entire portfolio matures on or before the day of maturity of the FMP. There are certain open-ended funds positioned by AMCs as maturity rolls down – the residual maturity of the fund comes down with passage of time. In a way, these funds imitate FMPs. in that the market-related volatility decreases progressively.

-Target-maturity funds: There are certain debt ETFs or index funds that have a defined maturity date. Technically, these are not FMPs but given that there is a stated maturity date, you can plan your cash-flows accordingly.

-Shorter portfolio-maturity open-ended funds: The lower the portfolio maturity of the fund, the lower is the variability in market movements. The relevance is through FMP investors wanted to reduce volatility as on maturity, the initially contracted rate is delivered. In open-ended shorter-maturity funds, there will be some volatility, but relatively lesser than longer maturity ones.

-Buy good credit-quality bonds/debentures and hold till maturity.

Conclusion

In the immediate future, interest rates are not going to rise significantly. Till interest rates increase and make FMPs attractive once again, the options mentioned above may be considered.

Source: https://www.moneycontrol.com/news/business/personal-finance/why-investors-prefer-open-ended-debt-funds-over-fixed-maturity-plans-6800431.html