Many fund houses sell short-term debt funds in India – popular products known as fixed-maturity plans – despite investor expectations of guaranteed returns, when no such guarantees exist.
Yet some firms are not engaged in FMP business, pointing to such products' unattractive risk-reward profile. Franklin Templeton Investments is one such manager.
“We don’t want mutual fund investors to believe that mutual funds are not subject to market risk,” says Vivek Kudva, managing director for India in Mumbai at the US firm. “Creating such a false impression is ultimately not good for the development of the industry.”
He says FMP managers are “running on a treadmill”. While the products are popular, notes Kudva, once they reach maturity and are automatically redeemed, the issuer could be forced to launch more if they do not want the firm’s AUM to shrink.
This is a challenge for managers. Despite the fact that firms make clear in their FMP product disclosures that there is no guarantee of return, they admit that those failing to deliver the expected yield would be unlikely to survive.
A typical one-year triple-A-rated FMP provides a pre-tax yield of 9-9.3%, says a source, but fierce competition means fund managers often earn fees of less than 10 basis points on these products.
Flows into FMPs have been rising fast, according to the Association of Mutual Funds in India. Last month, more than 90% of new monthly sales of funds (Rp105 billion ($1.76 billion)) went into FMPs, up from 69% in April 2013.
As of April this year, FMP assets under management totalled Rs1.69 trillion ($28.33 billion), about a fifth of India’s entire $158.14 billion asset management industry. That share of AUM has almost double from April 2013, when FMPs accounted for 11%, or Rp82.5 trillion, of Indian fund industry.
In India, corporations, banks and retail investors alike invest in FMPs, typically one-year closed-end fixed income products that automatically pay out on maturity. They are usually invested in money market instruments, such as bank certificates of deposit and corporate commercial paper.
Many investors think FMPs’ returns are guaranteed and that the products are therefore risk-free. But issuers are under no legal obligation to make up any shortfall if an FMP’s underlying securities experience a credit event or default.
The Securities and Exchange Board of India prevents managers from indicating a return in their FMP disclosures – but distributors are said to commonly make verbal undertakings to do so.
Failure to make such promises, and subsequently to cover a shortfall in the event of a default or credit event, could make it hard to attract assets.
“The risk is more for asset managers than for investors,” admits one executive at a foreign investment firm in Mumbai that offers FMPs. Liquidity of the money market is better than in corporate bonds, as a lot of banks participate in the money market and credit risk is far lower for banks than for non-bank institutions, he adds.
Market observers say funding a shortfall in the event of a default or credit risk is as much a commercial decision for the manager as a risk management issue.