Don''t ignore credit risk in FMPs: CRISIL

03 May 2007

Hardening rates have led to a revival of interest in fixed maturity plans (FMPs), which provide protection against rising rates to investors who hold till maturity. In addition, the projected returns are lucrative: indicative yields for several FMPs today are among the highest available for fixed income instruments of comparable tenors.

CRISIL's research reveals, however, that some FMPs have begun to move their investments down the credit spectrum in search of these high returns. This trend is clearly desirable from the perspective of deepening the bond market, but CRISIL believes that investors in FMPs today need to monitor credit risk more carefully than ever before, as any defaults in the underlying portfolio will eat into their returns.

Why FMPs are popular: FMPs are investment schemes floated as close-ended mutual funds, and have maturity periods ranging from a month to five years. The key to their popularity lies in their ability to generate steady returns over a fixed maturity period, immunising investors against market fluctuations. Unlike plain vanilla debt funds, FMPs are passively managed: the fund manager locks into investments with maturities corresponding to the plan's maturity, and normally does not disturb the portfolio thereafter.

Thus an investor who does not redeem before maturity is largely insulated from price risk, defined as the potential to make losses on bonds when interest rates rise. FMPs generally also offer higher tax-adjusted returns than fixed deposits (FDs) do.

Higher returns, more credit risk: Unlike returns from bank FDs and risk-free investments, FMP yields are indicative and not assured. Therefore, before investing in these instruments, investors
need to understand how FMPs achieve higher yields than FDs.