Is it time to shift your debt mutual fund investments to safer bank deposits?
FMPs are typically launched at financial year-end and redeemed at the beginning of the financial year, 3 years later, to avail of enhanced indexation tax benefit.
FMP or fixed maturity plan investors have been lulled into complacency for over a decade, with their investments redeemed on time, and with reasonable returns; the FMP defaults during the 2008 financial crisis, became a distant memory. Come financial year end in March, asset management companies launch a flurry of schemes enticing investors with “double indexation” benefit. March 2019 was no different with many FMPs floated by mutual funds.
It must have been a shock to investors just coming out of the year-end investment phase, to be told that some marquee funds will not be redeeming their FMP investment in full, on the date of maturity. The IL&FS and many other issues facing open-ended mutual funds had spared the closed-ended FMPs till now, not because the underlying securities in FMPs had a superior credit quality than the open-ended liquid, short term and other debt funds.
Investors who have been perusing the portfolio of their FMPs would have observed that many of the “AAA” NBFC and holding company securities which proved to be the nemesis of open-ended funds, had indeed infected the closed-ended FMP schemes as well. It is just that the credit quality issue, which has always lurking in the background, has exploded in the public eye, only at the time of the maturity of the FMPs.
It is interesting to note the timing of the current mini crisis, in the first few days of April 2019: FMPs are typically launched at financial year-end and redeemed at the beginning of the financial year, three years later, to avail of enhanced indexation tax benefit.
What can investors do?
The short answer is “nothing.” The existing investments in FMPs are locked in till maturity, with no liquidity available in the secondary markets.
As with open-ended funds, investors can learn some lessons from the current episode in closed-ended FMPs. Debt mutual funds on-lend investor money to corporate borrowers through securities. This is similar to the function of a bank. But there is a key difference. Banks cannot refuse to pay back fixed deposits in full on maturity date, citing NPAs. Nor can they delay repayment on account of delays from their borrowers. Mutual funds, on the other hand, can do both for FMPs.
It is unrealistic to expect that mutual funds have arrived at a magic formula by which their portfolio will have zero NPAs. No financial institution in the world has a zero NPA book. Debt mutual fund investors have to accept the reality that over a period of time, there will be credit losses, despite the underlying investments often being rated “AAA”.
This begs the question: why debt mutual funds, over banks, when the latter offer practically zero risk, with commercial bank bankruptcies unheard of, till now. In fact, retail investors, by spreading their fixed deposits over several banks, each with a cap of Rs 1 lakh, get deposit insurance protection, too.
Debt mutual funds offer certain unique advantages. They are much more tax efficient, compared to bank deposits. Debt mutual funds, including FMPs, carry indexation benefit and a lower rate of taxation if held for more than three years. They also provide an opportunity to indefinitely postpone taxation, until their investments are redeemed, though this is not possible in FMPs.
Debt mutual funds offer convenience of investment, through single window electronic channels. One can choose from a wide variety of funds, each with a different risk profile and duration/tenor. Redemptions, other than in FMPs, can be made in small or large amounts, based on actual needs. Returns too, could be better than bank deposits, though, as this week’s incident and many others reveal, investor’s capital could be at risk.
What can mutual fund managers do?
Since the financial year-end has just got over, this is likely to be a lean season for FMPs. Fund managers can design FMPs with themes like Banking and PSU FMPs and gilt securities FMPs, for the benefit of risk averse investors. And perhaps, a credit risk FMP too, for the yield hungry, risk taking investor! Such options available today in open-ended funds, can also be extended to investors in closed-ended FMPs. If there is a regulatory hurdle for launching such schemes, an effort can be made to reach out to SEBI for suitable guidance/amendments, through the Association of Mutual Funds in India (AMFI).
(The author is an expert in corporate banking and fixed income investing.)