Customer: So we have also invested in an FMP should I redeem?
PI Representative: I will not advise you that .You see FMP like Fixed Deposit will wither charge you on a redemption before the maturity date .which will cost you dearly.
Customer: But everybody is redeeming it’s in the news you see wait I will show you
Hindu Business Line
Redemption pressure
On the redemption pressure on mutual funds, especially the FMP schemes, Mr Raman said, “Corporates that have put money in mutual funds are taking it back as lending by banks is under strain. Though the Government and RBI have stepped in to ease liquidity, it may take 15 days to one month for the situation to ease.”
Source: http://www.thehindubusinessline.com/2008/10/18/stories/2008101851710100.htm
Sandeep Dasgupta, chief executive officer, Bharti-AXA Mutual Fund, admitted that liquid and FMP (fixed maturity plan) schemes have been under redemption pressure from corporate and retail investors. “As per the industry figure, around Rs 45,000 crore worth of funds have been redeemed in September,” he added. Redemption pressure picked up in the second half of September and has only intensified in October following the global financial crisis, he added.
Source : http://timesofindia.indiatimes.com/Ahmedabad/Investors_dump_equity_and_MFs_bank_on_good_old_fixed_deposits/articleshow/3610933.c
So I will also do that I think if people redeem the NAV falls right?
PI Representative: No the NAV falls when the value of the underlying asset falls when people redeem it’s the AUM [Asset under management] which falls. This will affect the NAV if the fund manager has not diversified enough, and “breaks” his “fixed assets” to give back the redemptions.
E.g. if the Fund manager has made an investment of 10 deposits of Rs.1 lakh his AUM is 10 lakhs ,When some one comes and redeems one lakh rupees he simply breaks his deposit of Es.1 lakh hence the AUM goes down but the yield will not .On the other hand if someone makes the redemption of Rs.90000 the fund manager has to invest Rs.10000 again which will cause a marginal dip in NAV typically the affect will be max to the extentent of 0.5% in a responsible fund house
If you remember in the previous article I had advised to check the rating and the underlying asset to decide whether you should invest in an FMP or not. And that’s the only thing that need’s your attention and care everything else is pure panic.
Let me explain “pure panic” with an example lets say you created a fixed deposit of Rs.1 lakh. Suddenly one of your relative comes and says that mr.x has met an accident and he / she needs 1 lakh on an urgent basis. You call your broker to check if you have some shares you can sell he says that you will have to book heavy losses and that he had planned for a better opportunity .You have a housing loan and a credit card bill pending as you had some big expenses this month .You can’t sell the property as there is no such need even if you did it would still take a lot of time to sell a topup loan will also take some processing time. You are in a fix and suddenly….it strikes
You have a fixed deposit receipt in the investment file nicely ticked in which matures next year. its the best option and it’s cheaper than a loan as well. So you break it
Customer : Hey don’t tell me that’s what’s happening if I break a fixed deposit it does not come in papers right ?
Let me elaborate from the information that you have given in the above extract & if you observe the figures closely you will see that mostly corporates are redeeming and their redemption is due to a need of money we call “liquidity”
In fact since you are talking of news let me share this article with you:
“CPI-M takes mutual fund route for better returns”
But when it comes to money, the communists are also saying its money, honey.
Source: http://www.ibnlive.com/news/cpim-takes-mutual-fund-route-for-better-returns/74771-3.html
Customer :
PI: Let me put it this way, trust or distrust with knowledge not news
Customer: OK !! So educate me why should I choose FMP over an FD and take that small but additional risk?
Secondly even at same rate FMPs earn better returns than FDs because of the differential tax treatment meted out to them. The differential tax treatment ensures that the net yield of FMPs for individuals falling in the higher tax brackets is greater than FDs. This is because interest earned on an FD is treated as other income and hence, taxed at regular personal tax rates. So, for a person in the highest tax bracket (income more than Rs 10 lakh) the tax rate would be 33.66 per cent. On the other hand, tax rates for FMPs are different. Following are the tax implications for FMPs:
· Dividend received is tax free in the hands of investors. However, a Dividend Distribution Tax (DDT) of 14.165 per cent is levied on the mutual fund company.
· Long-term capital gains (investment more than 365 days) enjoy indexation benefit.
· Short-term capital gains (investment less than 365 days) are added to the income of the investor and taxed according to his personal tax rate.
The illustration in the table below shows how the post tax return in FMPs is higher than that offered by FDs.
Fixed Deposit | Fixed maturity Plan- Dividend | |
Returns | 9 per cent | 9 per cent |
Income Tax | 33.66 per cent | N.A. |
Dividend Distribution Tax (DDT) | N.A. | 14.16 per cent |
Effective Yield | 5.97 | 7.72 |
Note: For the sake of simplicity, it has been assumed that the FMP has distributed the entire yield as dividend. The DDT is deducted on the gross yield. In actual practice, the returns on the FMP-dividend would be slightly higher than indicated.
PI: Your asset allocation suggests its time for ……..
Conclusion: FMP's have an additional risk associated with them which is justified by the additional return and the tax treatment gives it an additional advantage however if you do not wish to take that additional risk or do not have guidance of a financial planner to advise you which is the right FMP then may be FMP is not your cup of tea
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