It took $500 billion in asset write-downs to bring the more than $13 trillion-dollar American economy to nearly a grinding halt with a list of casualties that would have been the envy of any asset manager in happier times. Bear Stearns, Lehman Bothers, Fannie Mae, Freddie Mac, Merrill Lynch, and insurance big boy AIG. Naturally the American economy which lives on leverage (borrowing more than it earns) looks to be in a deep mess.

Since the economic liberalization in 1991, India has seen staggering GDP growth backed by relaxations in FII and FDI norms, catapulting the benchmark market index to 21000 levels in January 2008. The market is down nearly 50% and the mood remains apprehensive and pensive.
But despair is the time when true character is revealed, be it of any organization or individual - when pushed to the corner, its time for the champion boxer to take one more up his chin and still stand his ground.

Will India survive?

The point here is to know can there be a simple way for a small investor to instill confidence back on the street.

As markets across the globe are looking to pack their bags for a long time, in this entire mess one investor segment just might prove to be the saving grace: you and me. On 2nd April 2007, the BSE Sensex closed at 12455.37. on 31 March 2008 it stood at 15644.4, returning a cool 25.8%, year-on-year. RBI data for 2007-2008 suggested that only 10.5% of household savings found its way into the equity and debt markets amounting to Rs 77000 crore, the rest probably cooling its heels in the banks as currency or currency equivalents (Gold). This means that domestic households have matched the $15-17 billion brought in by FIIs for FY ‘08. Now with FIIs deciding to retreat and having already pulled out just over $9 billion from domestic markets since January ‘08, they would be rethinking about their equity allocation for India in the future. This makes way for a huge opportunity to Indian households who by increasing their share of investment in the domestic markets can hope to turn its tide as well as their own. As an individual investor, every incremental investment shall improve his/her long term (>1 year) returns. At the same time, incremental investment in gold would hedge him/her against any inflationary pressure and any unforeseen down turn.

50 million people in India are at present in the middle class category. This is expected to balloon to 583 million by 2025 according to a study by McKinsey & Co. This represents the real buying power. Even if we assume that these 50 million actually only save and their savings find their way into the banking system, imagine what a higher percentage of investment will do to the economy if they decide to flirt a bit more with the investments to savings ratio. We need to realize that FIIs are like mercenaries who will flee their camps first when the chips are down and that domestic investors are the real face of the investment community.

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.

Another question follows - Why?

The Indian debt market may be categorized into three - Government securities (G-Sec) consisting of central and state government securities, the bond market consisting of financial institutions (FI) bonds, public sector units (PSU) bonds, and corporate bonds/debentures.
Of these, the government securities segment is the most dominant category in the debt market. The most distinguishing feature of these instruments is that the return is fixed i.e. they are as close to being risk free as possible, if not totally risk free. The fixed return on the bond is known as the interest rate or the coupon rate.

Considering the scenario after independence, the immediate concern was to attract capital that would help the economy grow. This was the time when fixed deposits (FDs) in banks were considered safest form of investment that gave guaranteed returns and were risk free at the same time. But FDs have inherent disadvantages such as the amount always being fixed; and if interest rates dropped, investors tend to lose. At the time, the other option was the underdeveloped equity markets.

Thus the need arrived for instruments that could be traded on the market where the price discovery was far more realistic, favored the investor, and also offered liquidity.

This led to arrival of debt markets.

Cut to 1992 - Glasnost (liberalization) and perestroika (restructuring) swept through the financial markets as well. The country’s economy started changing tracks from a regulated one to a free market; it was then that interest rates became market forces-led rather than completely governed by the Reserve Bank of India (RBI).

India’s equity and debt market started walking in different directions charting their own course. The equity market survived its biggest scam in 1992, the result being the formation of the Securities and Exchange Board of India (SEBI). Badla was banned and the National Stock Exchange (NSE) was created.

Through all this, the debt market moved ahead, blocking fraud and improving systemic integrity, but there was no fresh vision on market design.

Moreover it lacked focus on retail investors, so much so that investors were not even aware about this avenue – where debt instruments could be traded just like equities. The risk is far lower in the case of bonds/debentures as compared to equities. Also, returns are better than those offered by fixed deposits in banks and they have high liquidity.

Another factor that has affected the growth of the debt market is the lack of infrastructure for price discovery and price information dissemination. Retail investors do not understand the mechanics of these markets in regard to instrument-pricing.

Therefore, the areas that need attention are investor education and creating a robust system that will allow this market to develop. The SEBI report on debt market recommends that concept of debt manager is quintessential to the development of the corporate debt market - who should be committed and sufficiently capitalized, who should subscribe, hold, and trade in debt.

Another jump, this time right up to the present, 2008: Inflation is at its peak – 7.8%. In such a scenario is it feasible to invest in G-Sec where the return is only 8%? Instead investors should consider balanced and equity diversified funds for higher returns than the inflation rate. Returns from equities are much higher.

The contrast between these two markets is for every one to see - the debt market does not cross a thousand trades a day, while the NSE has become the fifth largest exchange in the world, within striking reach of a million trades a day. The debt market probably has 20 dealers in one square kilometer of South Bombay whereas the equity market has vibrant presence right from Kashmir to Kanyakumari.

It is high time that the debt market takes lessons from the innovation-led equity market which has survived all odds and achieved a 180-degree turn around.

The author is Senior Editor at Apnaloan.com Services (P) Limited.