Why open-ended debt mutual funds score over Fixed Maturity Plans
By Vijay Mantri
Many asset management companies have been launching and continue to launch fixed maturity plans popularly known as FMPs. The reason these products are a hit with many investors is very simple — there is predictability of investment outcome. A typical FMP has a fixed maturity ranging from 1 month to 3 years or sometimes even more than that. Based on the tenure of the FMP, a fund manager invests in various fixed-income instruments in such a way that all of them mature around the same time. Thus, investors get an indicative rate of return of the plan.
FMPs seem attractive when the prevailing interest rates are higher. Hypothetically, lets assume that the investor thinks he will get 10-11% annualised return in times of high interest rates. If he compares the performance of existing mutual fund schemes with FMPs, mutual funds dont seem very lucrative. This is because whenever interest rates in the economy go up, debt mutual fund schemes tend to show low or even negative returns because their underlying portfolios are marked to market. Invariably, FMP returns are higher.
However, our research at JRL Money shows a different picture. On a sample basis, we picked a few fund houses and compared the performance of their FMPs (with 3 year+ maturity) with the performance of the same duration openended debt mutual fund schemes. We found that open-ended schemes consistently outperform FMPs. Because of valuation norms and short-term volatilities in the market, returns of open-ended scheme might not seem attractive at that moment, but their performance has been superior to FMPs.
Let me give another illustration. If the same paper is held by an FMP and an open-ended debt scheme in their portfolios, the behaviour will be identical in both. If the interest rate in the economy rises, then the NAV of the open-ended debt scheme will drop, and so will the NAV of FMPs. Even though NAV drops, investor will still be okay with FMP as he thinks – I dont have to worry because at the end of that period, I know what I am going to get. In this case, even though open-ended scheme and FMP are holding the same underlying security which delivers the same returns, investor is still comfortable with FMP. This is the investors optical illusion.
The other important factors where I think FMPs do great disservice to the investors are:
- FMPs defy the very logic of mutual funds. Mutual fund is a market-linked product; it gives market return and market returns can never be predictable. If the FMP tells investors that the returns are predictable, then the asset management company is creating a false sense in the mind of the investor. It defies the very essence of market return product.
Second challenge with the FMP is of liquidity. When someone puts money in an FMP, that money is locked in till the maturity of the plan. Even though these FMPs are listed on the stock exchange, in reality their trading volumes are very low. In effect, there are hardly any trades taking place on those FMPs. So, there is absolutely no liquidity for the investor. So even if you need money in between you cannot take it out.
Another issue that the investor faces if he invests in FMPs is the portfolio risk. If anything goes wrong in the portfolio of that FMP, then the investor is at the mercy of the fund house and he cannot take any corrective action immediately. Now, lets see how open-ended mutual funds are beneficial in this aspect. Had the investor put the money in an open-ended debt scheme of the same fund house with the same underlying securities, at least he would have had the choice to take money out whenever he perceived risk. He wouldnt suffer that kind of losses which hRead More – Source