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Why are Open Ended Debt Mutual Funds Better than Fixed Maturity Plans?

Karan Sharma Karan Sharma 25 June 2019

Do Fixed Maturity Plans always seem attractive? Aren’t you eager to compare and weigh alternatives and find out what open-ended debt mutual funds are all about? Here’s how different they are from fixed maturity plans...

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Recently, there has been a surge of fixed maturity plans (FMPs) in the economic market. Many asset management companies are heavily promoting fixed maturity plans. So, what is a fixed maturity plan? A fixed maturity plan is a type of a close-ended debt fund. A close-ended debt fund comes with a fixed maturity period and invests across a wide range of debt instruments such as highly rated securities and government bonds. Investments made in a fixed maturity plan can only be done during the time of a new fund offer. A fixed maturity debt fund ensures investors get a predictable rate of interest.

A standard fixed maturity plan has a fixed maturity ranging from 1 month to 3 years or more. To increase the yield, the fund manager invests in different debt securities and ensures that all of them mature at or around the same time-frame.

Why are FMPs attractive?

A fixed maturity plan is an attractive option only when the prevailing rate of interest is higher (that is around 10%-11%). In comparison to a regular mutual fund, these returns are low. Also, debt funds do not operate like equity funds. During times of high interest rates (when the economic market is in good condition), a debt fund is marked to a market, hence, it will show low or negative returns. Additionally, a fixed maturity plan comes with minimum exposure to interest rate risk. This is because the instruments which make up the fund are held by the fund till maturity, which allows it to yield a relatively fixed rate of return.

Another reason why a fixed maturity plan is attractive is when you opt for a fixed maturity plan, it comes with a tenure greater than one year. You can benefit from indexation to leverage your tax liability against inflation. For this purpose, you can even opt for triple indexation. This will give you the advantage of indexing your investment to inflation for four years while you remain invested for a period of three years and over.

What do FMPs invest in?

Fixed maturity plans generally invest in the following securities:

  1. Commercial Papers (CP)
  2. Certificate of Deposits (CD)
  3. Corporate Bonds
  4. Money Market Instruments
  5. Government Issued Securities
  6. Non-Convertible Debentures

Open Ended Debt Mutual Funds vs Fixed Maturity Plans

Here are a few reasons why open ended debts funds are better than fixed maturity plans:

  1. The very concept of a fixed maturity plan defies basic logic. An open ended debt mutual fund is a market-linked product (it is defined by market-linked returns and can never be subjected to predictability). The fund manager of a fixed maturity plan states that the returns of their FMPs are predictable.

  2. The second problem arises out of liquidity. For an individual who has invested their savings in a fixed maturity plan, the money is locked till the maturity of the plan. Even the trading volumes of these funds are very low irrespective of whether they being listed on the stock market exchange. Thus, there is absolutely no liquidity in case you need to take out the money from the fund in case of an emergency.

  3. Another underlying problem which comes with a fixed maturity plan is the portfolio risk. As an investor, you are at the mercy of the fund manager/AMC in case something wrong happens to the fund. On the other hand, if the same money was invested in open ended debt mutual funds, the investor has got full rights to remove their money out of the fund house. Additionally, in an open ended debt mutual fund, marking to market happens on a consistent basis. This gives the investor ample time to take corrective measures anytime they want.

  4. Fixed maturity plans come with a very short opening (new fund offer). When the fixed maturity plans are released for subscription in the market, it is only for a short span of time. During this period, the fund manager or asset management company pools money in a short period of time as the investing window is also short. It is quite a difficult task to get the right securities (papers and bonds) of the fixed maturity plan in such a short period. In case the quality of the portfolio is poor/not diversified, the entire fund will suffer. This is harmful for the investor. In comparison to an open ended debt mutual fund, the standard holding of a single security is not more than 3%-4%. Under a fixed maturity plan, the standard holding in a single security can be very high (for some particular groups, it can be as high as 25%).

To help you understand better, you can go through the following illustration

Suppose you take a few fixed maturity plans of a particular fund house with a 3-year plus maturity date and compare their performance for the same duration with open ended debt mutual fund, you will find that open ended debt mutual fund schemes out perform fixed maturity plans. Returns of open-ended debt schemes are superior irrespective of any short-term volatility in the market.

If the same set of securities is held by an open ended debt mutual fund scheme and a fixed maturity plan, the behavior of the securities will be identical in both the schemes. Example, if the interest rate in an economy rises, the Net Asset Value (NAV) of both the schemes will drop. An investor is comfortable with a fixed maturity plan because he/she is under the assumption that they will receive a fixed return at the end of the maturity plan. This is not true, because in case the fund house fails, the investor will not be able to take their money out. On the other hand, an open ended debt mutual fund provides market-linked returns.

From the above situations, we can clearly determine that open ended debt mutual funds are better than fixed maturity plan. As mentioned before, fixed maturity plans defy the very logic of mutual funds and market-linked returns. You should always look at the performance of the fund before investing.

Recommended Read: How to Choose the Right Hybrid Mutual Fund?

Karan Sharma
Written by Karan Sharma
Content Specialist and Strategist, foolishly creative and always ready for a game of 'Call of Duty'.