THERE has been a spate of recent advertisements seducing investors towards the monthly income plans (MIP schemes) of mutual funds. Despite all advertisements of mutual funds bearing the warning that past performance does not guarantee future performance, the lay investor can and does get swayed into thinking that the good times will roll forever.
This category of investment was launched during the start of the stock market boom, and hence had a dash of equity built into the scheme. The objective was to pay out monthly dividends — this would be tax-free in the hands of the investor and thus have an edge over the relatively safe schemes such as the Post Office Monthly Income Scheme. Over time, we can now invest in quarterly and annual options, or even the growth option, making us wonder whether the title of the scheme needs to be renamed.
Structure Of The Scheme
MIPs are hybrid MF schemes which invest mainly in debt (fixed income) products. These provide safety to the portfolio and allow for regular returns to be paid out. Some equity is added to this scheme to provide the "kicker" while taking some risks. MIPs come in different shapes and sizes, and equity exposure ranges from a low of nil or 5% to as high as 30%. Obviously, the risks and returns vary widely.
Recent Performance
For the purposes of this article, I selected one scheme in this category which is among the better performers and has a mandate of going up to 25% in equity.
During the past 12 months, this scheme has returned 24% (on the back of equity returns of 75% in the past year) as of the last week of April. To put into perspective, this scheme earned 23% returns in a three month period between March and June last year; and this may not be replicated some time soon.
The Devil Is In The Details
The objective of investing in a predominantly debt product is safety and hence excessive risks must be avoided. On analyzing the returns from 2006 onwards, quarter on quarter, we find that this scheme has yielded negative returns in 3 out of 17 quarters. (Refer the table for a more detailed analysis of this scheme).
What is clear from the table is that MIPs need to be invested in with a two-year time horizon at least if one does not want to take risks. Investing in schemes with a lower equity exposure would be another way to achieve that objective.
The Planner's Perspective
Hybrid schemes such as MIPs are a method of achieving asset allocation. As a financial planner, however, these schemes do not find favour because of the following reasons:
• Tax treatment for the equity component is disadvantageous as MIP is treated as a debt product (and equity gains are taxed at a lower rate or not at all currently)
• Expense ratios on these funds are higher than what one would pay if one could allocate the same funds into 75% debt and 25% equity schemes (as in this example)
• The nature of debt investment (duration of paper, which is one of the critical factors to ensure returns and reduce risks) and equity investment (whether large-cap or mid-cap) can change during the time that one is invested, thereby altering the risks that an investor would like to take.
So tread with caution in this alluring world of MIPs.
