There has been a spate of fixed maturity plan (FMP) launches in recent weeks. The reason is not hard to see. After all, FMPs are an attractive investment option whenever interest rates go up, as they have lately.

FMPs are basically close-ended debt funds that invest in government securities, corporate bonds and money market instruments. These schemes typically hold their debt investments to maturity — so a 30-day FMP will invest in debt instruments that have a matching maturity. Thus, the scheme’s returns, while they are not assured, reflect the interest rates prevailing in the market at that time. Investors too need to remain invested in the FMP till maturity to take advantage of this.

Interest rates — and bond yields — especially in shorter maturity paper have firmed up since mid-April. For instance, the benchmark 10-year government security was trading at an interest rate or yield of 7.94 per cent on March 31. This touched a high of 8.24 per cent on April 22, although it came off a bit subsequently.

The three-month FMPs that closed recently were thus offering indicative returns of 8.75 per cent. Most investors typically use FMPs to park their money for the short term.

“FMPs will retain their flavour as long as the RBI maintains its tightening monetary policy stance,” says Umesh Sharma, fund manager, fixed income, Lotus India Asset Management Company. Certainly, there are enough undercurrents to keep rates tight, at least in the near term. “Interest rates will be volatile till there is clear visibility on inflation,” feels Sharma.

And visibility seems unlikely at least till July, when there might be more concrete evidence of a normal monsoon, and consequently some easing up of food-related inflation. Remember though, that, high crude and commodities prices have also contributed to the inflationary pressure.

On the other hand, liquidity or the money supply in the market, which also impacts interest rates, is ample currently. Also, a softer monetary policy stance could even cause interest rates to come off.

Sharma also points out that, “Pressure on economic growth is building up with the RBI’s tight monetary policy over the last year or two now starting to take effect and interest costs of companies going up.”

Any contraction on investments could thus lower economic growth even below the 7.5 per cent to 8 per cent expectation by next year, he feels. So in the long term (read a year), an economic slowdown could lead to easing of interest rates. “But in the near term, monetary policy will dictate the direction of interest rates,” says Sharma.

FMPs offer a tax advantage over bank fixed deposits (FD). The interest income earned on FDs is taxable — it is clubbed with the individual’s income and taxed at the applicable income tax rate. In contrast, if you invest in the dividend option of an FMP, the dividend is tax free in the hands of the investor though the mutual fund will levy a 14.5 per cent dividend distribution tax.

Remember though, that FMPs could carry a credit risk, especially if the schemes invest in lower-rated corporate bond papers.