The MIP catch

Do not expect monthly income from a Monthly Income Plan. Sounds strange? It is -- and true too.

The MIP tag, to say the least, is misleading. The problem is not with the product per se, but the way it is marketed.

MIPs are indeed fantastic products. They are debt-based mutual funds which have the luxury of investing in about 10-20 per cent of their portfolio in equity instruments. The equity exposure is pretty much permitted in their offer documents.

The product makes perfect sense especially looking at the returns on alternate asset-classes. Bonds, which constitute the core of most household portfolios, are losing their sheen.

Since the running yield in the market currently is not more than 5-6 per cent, the only way to earn a decent return on your investment is to deploy a small portion in equities.

Why equities? Equities are proven to be the most lucrative asset class in the long-term.

But the problem is while they give the best returns over the long term, they are prone to serious short-term volatility -- mood swings in equity markets have a major bearing on the net asset value of MIPs. That's one reason MIPs cannot provide regular income.

Take for example, an MIP with a debt exposure of 80 per cent and an equity portfolio of 20 per cent with an NAV of Rs 10.

Assuming a principle return on your debt portfolio at five per cent, even a 20 per cent drop on the equity side is enough to bring your returns to zilch. By the same token, a 25 per cent drop in equities can make your returns enter negative territory.

Now consider the case of an MIP with just 10 per cent exposure to equities. Even a 10 per cent erosion in the equity holdings of such a scheme can wipe as much as 1 percentage point off its returns.

While these are hypothetical cases, they are not entirely inconceivable, given the volatility. In the past, MIPs have skipped dividends in months of high volatility in stock prices.

But this is not to say MIPs are bad investments. But investors need to understand the risks involved in the product and not go by the name alone.

What to look for:

View MIPs as closed-ended funds with maturity of 3-5 years. It is only over a medium to long timeframe that one can realise good value from equities and hence, from your MIP investment.
Choose a growth plan rather than a dividend plan. In other words, do not invest in them with a view to earning a monthly income because you may be disappointed by a bad market.
If indeed you want a product which gives monthly income, consider Post Office products. The returns are lower but you may not lose sleep over not having money to pay your monthly expenses.