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Nature of equity-linked fixed maturity plans

business Updated: Feb 24, 2008 21:55 IST
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The financial world is full of innovations. However, lines between different instruments blur after sometime, giving the investor an opportunity to step back and take a close look at what is happening to the instruments considered for investing. Equity linked fixed maturity plans work on a similar premise.

An equity linked fixed maturity plan is a close-ended mutual fund scheme. It consists of a specific time period for investment and a particular date by which the scheme will come to end. The difference lies in the composition of the portfolio of the scheme. As their name suggests, equity linked fixed maturity plans have some amount of equity present in the portfolio, unlike a normal fixed maturity plan (FMP) where the debt in the portfolio matures on the date of the scheme.

The first thing that the investor should ask is how the process helps them because the introduction of equity means that there is some risk to be taken care of. The normal expectation of the investor is that when they invest in a FMP is that certain returns will be earned when they hold the scheme till maturity. The scheme tries to eliminate risk by a mode of structuring the portfolio.

Here the scheme is structured in such a manner that the investor will get his original investment back just through the debt investment while the equity part of the portfolio will generate some returns. This makes the nature of the scheme somewhat similar to a capital guaranteed scheme where the capital is secure no matter what happens and then the investor is able to gain from the upside through the investment in equities.

In a FMP, where there is only debt the indicative returns are known at the time of the investment. In this case the return figure cannot be estimated beforehand but the downside is known. Even if the equity part shows some losses there will be a rise in the net asset value because the par value is present just by the debt part. This makes the entire equity part the driver of returns as far as the investor is concerned. A tough time on the stock market at the time of maturity might also lead to a situation where the investor will realise that the final return has been impacted.

(The author is a certified financial planner)