Not only equities are volatile; debt too can witness bouts of volatility. Under falling interest rate scenario, bond prices rise and yields fall and vice-a versa. However, there are intermediate periods of uncertainty where direction of interest rates cannot be predicted with certitude. Under such circumstances investors find solace in Fixed Maturity Plans (FMPs), a subcategory of debt mutual funds. In simple words, FMP is a close-ended fund investing in debt instruments of maturities concurrent with that of the fund itself. Through FMPs investors try to lock in their money for pre-specified time period and negate the interest rate risk. Maturity profile of FMPs ranges from 1 month to 3 years while most of them have a maturity of less than 1 year time period.

Where do they invest?

FMPs largely invest in Certificates of Deposits (CDs) issued by banks and in Commercial Papers (CPs). They also, at times, invest in other debt instruments issued by corporate and may even park in term deposits with banks. In addition, the fund manager may consider investing in any other debt instruments too based on the tenure of FMP.

What affects yields on FMPs?

Besides interest rate movement, liquidity situation in the system affects the yields on FMPs. The combination of both, i.e. interest rate scenario and liquidity situation decide the attractiveness of FMPs. When the rates are tight and liquidity situation is stressed, usually FMPs quote at higher yields as raising money becomes difficult. But when rates start going down and liquidity situation eases, FMPs settle for lower yields.
 

Change in the repo rates	Liquidity pressure

(Source: RBI, PersonalFN Research)  

As depicted in the graph above, the policy rates have started dropping since April 2012. On the other hand, despite the lesser government spending, liquidity situation in the system has improved considerably in last couple of months as RBI has been injecting liquidity through Open Market Operations (OMOs). Over last few months inflation has fallen substantially but industrial production remained subdued. On this backdrop markets have been expecting RBI to continue to lower rates. On these hopes, bond prices have already rallied. As a result FMPs have started losing their shine. In the past 3 months, some mutual fund houses withdrew their New Fund Offers (NFOs) while a few extended the last date of their NFOs which again shows that popularity of FMPs has gone down due to macro-economic conditions.

Road Ahead...
Owing to high Current Account Deficit (CAD) and falling rupee which threatens to destabilise the economy; RBI has refrained from cutting rates further in the 1st quarter mid-review of monetary policy. However, citing the slump in the growth, as measured by GDP and IIP, markets would again start expecting a rate cut at the 1st quarter review of monetary policy which is scheduled on July 30, 2013. This might again put pressure on yields and may push them down. RBI has hinted that it will actively manage liquidity position which may help avoid any crunch in the system. As a reason, FMPs are unlikely to become attractive again.

What investors should do?
PersonalFN believes that investors should not try to time the market and should avoid speculating on interest rate movement. Under present scenario where FMPs have clearly been losing their flavour, investors should consider various options available to them. Those eyeing short term, should restrict their investments to liquid and liquid plus funds. Investors with longer time horizon say, 3 years and above, may be better off investing in duration / flexi debt funds provided they have a higher risk appetite. The fund manager of duration / flexi debt fund alters the maturity profile of the portfolio as per the attractiveness of a particular segment of the yield curve. Nonetheless, those investors who may still prefer FMPs should consider those with a lower maturity profile.

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