What are Monthly Income Plans?
Monthly Income Plans or MIPs are mutual fund products designed with the objective of giving a regular return (in the form of dividend) in addition to capital appreciation to investors. The periodicity of return depends upon the option chosen by the investor. MIPs generally come with the monthly, quarterly, half-yearly, yearly and growth options. Investors, who choose the growth option, are not entitled for a return by way of dividend, but gains in the form of capital appreciation.

To realize its investment objective (of providing regular dividends), an MIP has the option to invest some portion of its assets (about 10-25%) in equities and the balance in debt and money-market instruments. Having exposure in debt and equity an MIP takes benefits of both equity as well as debt markets.
Since MIPs have a higher debt component, these schemes are categorised as debt-oriented hybrid funds.
However, like any mutual fund products, returns in MIPs are market-driven and dividends are declared out of the available distributable surplus only. There is no guarantee of a monthly income distribution.

How is it different from the income funds and bank FDs?

MIP vs. Income Fund:

• MIP has an option of investing a small portion in equity whereas an income fund invests only in fixed income securities i.e. corporate bonds, govt. securities and money-market instruments like Treasury Bills, commercial papers, CBLO etc. In a booming equity market, MIP with its small equity exposure rides along the trend, while income funds can’t cash on the same.

• Though income is not guaranteed, still MIPs strive to provide regular dividends as per the option of the investor. MIPs manage to do so due to the small equity portion which acts as a kicker. On a sustained basis a pure income fund would be hard pressed to distribute monthly dividends.

To present a more realistic picture, during the last few years, the average return of an MIP has been 12% p.a. as against 7% of an income fund.

MIPs Vs Fixed Deposits (FDs) of Banks:

• Returns on fixed deposits of banks are assured whereas there is no assurance on the returns on MIPs.

• Amount invested in FDs are locked-in till the term of the deposit. If withdrawn pre-maturely, then penalty is imposed on the investor. Partial withdrawal of amount is not allowed. Whereas, investment in MIPs can be withdrawn on any business day at the prevalent NAV. Even partial withdrawal of amount (units) is allowed subject to the minimum amount of investment in the scheme.

• Returns on FDs are low compared to MIPs owing to the difference in the asset allocation pattern.

• MIPs are more tax efficient than FDs. Dividends declared under MIPs are tax-free at the hands of the investors. Income from bank FDs is taxable as “income from other sources” and is taxed depending on the tax bracket of the individual. Further, if the interest income exceeds Rs 5000/- in a financial year, then TDS is applicable.

To compare the returns of FDs as against MIPs (as on 31st March 08), yield on FDs of State Bank of India (considered as risk-free return) for 1 to 3 years period were in the range of 6 % and 8.5 % p.a whereas annualized return generated by MIPs for the above corresponding period have been around 10 to 14%.

Who should invest in MIPs?

• Investors in the age group of 50+ years: MIPs are suitable for conservative investors who want to earn marginally better returns than a debt-only portfolio. Conservative investors generally remain invested in fixed income instruments, but sometimes they need returns that are above the inflation by a few points. Equity exposure is the best way to provide this meaningful return over the inflation. An MIP typically invests bulk of its assets in debt, while a small equity exposure is maintained to earn a slightly higher return.

Typically, an investor who is either past his/her retirement or is nearing it may consider MIP as one of the many options. To that extent, MIPs suit the investor profile of a retiree/semi-retiree where the monthly/quarterly/half-yearly/yearly income from the scheme helps to meet their regular expenses.

• Investors in the younger age group, HNIs, institutions, and trusts: In the regime of lower interest rate, growth option of an MIP scheme becomes attractive. At present, risk-free 1 year bank deposit offers maximum rate of 9.5% per annum. Returns from MIPs will definitely yield higher if the interest rate continues to remain low. Investors in the younger age group, HNIs, institutions, and trusts etc. do not require a regular monthly/quarterly/half-yearly/yearly dividend inflow. However, capital appreciation with a controlled level of risk is an extremely important parameter for investment. The controlled equity exposure of 10 - 25% over the medium term should generate higher returns, compared to a pure debt fund, albeit with a slightly higher level of risk.

Last words
Like any mutual fund product, there is no assurance that an MIP will declare dividends regularly though they strive for the same. It becomes difficult for MIPs to keep up the regularity when the equity markets remain volatile for longer periods. In such a scenario, investors can have the option of switching into the growth option under the same scheme with a SWP (Systematic Withdrawal Plan) facility. However, a comparative study of some of the MIPs shows that despite skipping declaration of dividend for some months, the return given has been far superior to other comparable debt investments.
MIPs can be positioned aggressively to the people nearing retirement. These people would like to save so that on retirement they would get a steady flow of income at a higher real rate of interest (approximately Rate of interest minus inflation) to meet their regular expenses at the same time have capital appreciation.
Given its wide-ranging appeal to conservative and aggressive investors, MIPs have the potential to be very much there to cater to these segments. Further MIP not only offers stable returns but also provides additional incentive of higher returns (should the equity portion do well).

The author is a Fund Manager in LIC Mutual Fund.