Crisil Research Report
'FMP investors need to monitor credit risk'

PFW Bureau / May 4
The hardening of interest rates have led to a revival of interest in fixed maturity plans (FMPs), which provide protection against rising rates to investors who hold till maturity. In addition, the projected returns are lucrative, indicative yields for several FMPs today are among the highest available for fixed income instruments of comparable tenors.

CRISIL's research has conducted a study on FMP which reveals that some FMPs
have begun to move their investments down the credit spectrum in search of these high returns. This trend is clearly desirable from the perspective of deepening the bond market, but CRISIL believes that investors in FMPs today need to monitor credit risk more carefully than ever before, as any defaults in the underlying portfolio will eat into their returns.

Why FMPs are popular: FMPs are investment schemes floated as close-ended mutual funds, and have maturity periods ranging from a month to five years. The key to their popularity lies in their ability to generate steady returns over a fixed maturity period, immunising investors against market fluctuations. Unlike plain vanilla debt funds, FMPs are passively managed, the fund manager locks into investments with maturities corresponding to the plan's maturity and normally does not disturb the portfolio thereafter.

Thus, an investor who does not redeem before maturity is largely insulated from price risk, defined as the potential to make losses on bonds when interest rates rise. FMPs generally also offer higher tax-adjusted returns than fixed deposits (FDs) do.

Higher returns, more credit risk: Unlike returns from bank FDs and risk-free investments, FMP yields are indicative and not assured. Therefore, before investing in these instruments, investors need to understand how FMPs achieve higher yields than FDs. One of the ways in which FMPs have increased their indicative yields is by investing in credits that are not in the highest safety category, in keeping with the classical risk-return paradigm. This is a departure from the earlier practice of funds investing largely in the highest and high safety (AAA and AA rated) debt issuances, and thus presents a risk that FMPs face relating to the credit quality of their portfolios.

The need to monitor credit risk: CRISIL believes that credit risk monitoring is a key imperative for investors in FMPs. Reliable in-house or third-party evaluations of credit risks, such as CRISIL's Credit Quality Ratings (CQRs), allow investors to evaluate the credit risks in FMPs, and help them take investment decisions that are appropriate for their objectives and risk appetite.

According to Mr. Krishnan Sitaraman, head, CRISIL Ratings, “Investors' willingness to put their money in lower-rated credits augurs well for India 's corporate debt market, and is welcome.

However, the risks associated with this have to be understood and should be aligned to the risk profile of the investors.” Investors in FMPs need to be aware of the credit quality of the portfolio at all times, and of the fact that the targeted returns are possible only when there is no default in the underlying securities, he added.