A recent addendum by Aditya Birla Sun Life suggested that investors rollover some of the AMC’s FMPs that are maturing. The reason was that given the low-rate scenario, investors are unlikely to get good interest rates outside once they exit. And that staying invested would provide indexation benefit for capital gains and earn higher returns.
But some investors raised the doubt on whether the FMPs under question were in trouble. We therefore looked at their portfolios. They had high-quality AAA-holdings that are unlikely to have had any pressure on repayment. In other words, there does not appear any credit-related rollover compulsion.
Still, we think it is not a good idea to rollover your FMPs in general, and specifically at this juncture. Know why, in this article.
#1 Rate cycle matters for FMP
FMPs lock into interest rates because they are held-to-maturity instruments. They cannot change their duration. They cannot change the underlying instruments to add higher-coupon earning papers if they come up after the FMP is launched.
Yes, it is true that even at this juncture, FMPs may lock into corporate bonds that yield higher than FDs. But that need not be particularly more beneficial for you for the following reasons:
- One, the 1–2-year spread (excess over government securities) for AAA corporate bonds is only 60-65 basis points. 2-year G-secs are currently at 4.7%. So, you cannot expect to be locked into significantly higher rates in AAA-corporate bonds considering the current spread. The spread gets wider (almost 180 basis points) only if the portfolio has instruments that are AA or below rated (in other words, credit risk).
Simply put, the 3-year returns (which is 7.5-7.9%) from the 3-year FMPs with AAA-rated portfolio may not hold up if your FMP extends the maturity by, say, 2 years. So, if you rolled over believing that you would be able to get similar or higher returns, you may be disappointed.
- If you believe that rates will go up from here, you are better off investing in open-ended ultra-short or short duration funds where the yield reset (from the higher rates that papers would carry) will be quicker and higher. Or you may wait it out with very short-term FDs and enter these shorter duration funds when there is clear sign of uptick in rates. This way you can avoid any short-term mark-to-market losses.
- If you believe that rates will remain stagnant as the RBI tries to keep the yield rise at bay, then you are still better off waiting it out with open-ended shorter duration funds than locking in and missing out on any yield hike, say a year later.
- Whether you invested in a shorter duration fund or even a longer duration corporate bond, the fund can add higher yielding papers (redeploying fresh money and existing papers that mature) and up your overall returns through accrual (interest income). This is not possible with an FMP.
To sum up, when you have the option of waiting for higher yields, there is not much reason to lock into current rates now.
#2 Not knowing the credit risk
Many investors who lock into FMPs are not aware of the credit risk profile of the FMPs. FMPs do state this upfront in their scheme information document. For example, check the SID of Nippon India FHF 40 – Series 8. The SID has stated that the FMP will invest 75-80% in A-rated instruments and 20-25% in AA-rated papers! No high quality here! This fund house has exposure to B+ rated Vodafone Idea, the defaulted paper of Altico Capital and many other high credit risk papers. This FMP matures only in May 2022, but we are just using this as an illustration to show that FMPs do carry credit risk as well.
Of the FMPs currently active, papers below AA+ account for only 10% of the total AUM of these FMPs. However, there are individual funds with high exposure. But if you invest in the FMP knowing that you’re taking credit risk (since the FMP declares it upfront), why should you worry?
Because, if you were to rollover funds with such high-risk papers, you would not know whether the fund house was under compulsion to rollover due to repayment issues. Even as it is risky to lock into such high-risk papers for the first time, you may be stretching your luck too far by doing it once more. Here is a list of FMPs (active ones) their exposure to papers below AA+ with FMP maturity.
This list may not be an all-comprehensive one (as we have downloaded this from our MF database) but will give you an idea of why you should check portfolio before taking a call to rollover, in any rate cycle.
#3 Idea of FMP
When you invest in an FMP, the idea is to typically align your goals with that of the FMP’s tenure and use the money for what you had originally intended. Or you invest because you want to lock into favourable rate movements (typically when rates peak). When the current scenario (of roll over) does not offer either of these, taxation should not be the only reason for you to again lock into it and curtail your liquidity. Even if you did have an extended timeframe and did not intend for the FMP to meet a need, there is certainly nothing that prevents you from going to open-ended funds that will suit your tenure and provide liquidity.
You need to be aware that retaining your assets would be a primary goal of any fund house when you are advised to rollover. But that need not be your objective!