Investors would have noticed that returns on fixed maturity plans (FMPs) aren't what they used to be. Gone are the days when you could expect double-digit returns on FMPs (we are talking of the period around March 2007); currently FMPs yield a return of around 8%.
It's the same story with fixed deposits (FDs) as well, with banks revising their deposit rates downwards. This has got risk-averse investors very worried and they are forced to re-evaluate their options.
No doubt, investors who have already invested in higher yielding FMPs and FDs are sitting happy. At Personalfn we have been advising clients since February 2007 (when FMP yields began peaking) to invest in FMPs mainly for two reasons -- higher yields and superior tax-adjusted returns.
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But that party seems to be getting over. FMP yields are now hovering around 8% and the table below shows the difference it has made to returns.
FMP yields take a hit
| Yield | Post Tax Return | |
| 366-day FMP (March 2007) | 10.25% | 9.19% |
| 366-day FMP (July 2007) | 8.00% | 7.18% |
Post-tax return for investors who had invested in FMPs in February-March 2007 is 9.19%. At present, investors who are considering investing in FMPs have to deal with considerably lower yields, which put their post-tax return at 7.18%. In a matter 4-5 months yields have slumped by one-fifth.
FD investors are no better off. Fortunately for them, rates on bank FDs do not fall as abruptly as yields on FMPs. But there are no two ways about the fact that FD rates are set to decline.
What investors must do
Risk-averse investors must now look for investment options that can give them that extra return, a role that was until now played by FMPs and FDs.
1. Within the debt spectrum one way to make the best of falling rates is to invest in long-term debt funds. As rates fall, prices of bonds and government securities (gsecs/gilts) firm up, since there is an inverse relationship between bond prices and bond yields. Rise in bond/gsec prices pushes bond fund net asset values (NAVs) higher.
One investment option, within long-term debt funds, that merits a look-in is the long-term government securities (gsec) fund. As is evident from the name, these funds invest primarily in gsecs. Because of the higher liquidity and the buy/sell spread, gsecs are usually more sensitive to changes in interest rates. When rates fall, gsecs are the first to reflect this through higher prices, which in turn gets reflected in higher NAVs.
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2. Investors who can take on a little risk can consider investing in monthly income plans (MIPs) that have moderate equity allocations. MIPs are hybrid funds that invest predominantly in debt combined with smaller equity allocations.
The debt-equity allocation is predetermined; most MIPs usually invest 10%-25% of assets in equities with debt investments accounting for the balance. The objective is to aim for stability through a predominantly debt portfolio without sacrificing growth, which is why equities are in the portfolio.
While MIPs can be volatile in the short-term, over 18-24 months the volatility is considerably lower. Also investors must note that although the name suggests otherwise, MIPs do not assure an income (dividend). If investors are looking for dividends, then they are better off opting for the quarterly dividend option.
Primarily, these are the two key options for conservative investors in a falling interest rate scenario. Investors can also consider investing in both viz. long-term debt funds and MIPs based on their risk appetite and asset allocation. The important thing is that investors are aware of the change in the interest rate scenario and gear themselves to counter it.
By Personalfn.com, a financial planning initiative
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