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The MIP Flavour – Part 2 - Views on News from Equitymaster
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  • Oct 3, 2000

    The MIP Flavour – Part 2

    We had discussed the mechanics of monthly income plans (MIPs) in ‘The MIP Flavour – Part 1’. In this part we take a look at MIPs in the backdrop of turbulence in equity markets and rising bond yields. We also take a look at how MIPs fare vis-à-vis other comparable investment avenues.

    MIPs vis-à-vis other mutual fund products
    The MIP investor is one who is either past his/her retirement or is nearing it. To that extent, MIPs suit the investor profile of a retiree more than other comparable investment avenues in the mutual fund industry.

    Monthly Income Plans NAV
    1 month 3 month 6 month 1 year Since
    Sun F&C MIP (Mthly) 9.8 0.8% -1.9% - - -7.6%
    Alliance MIP (Mthly) 10.0 0.1% -0.6% -1.4% 15.4% 18.7%
    Templeton MIP (Mthly) 10.0 0.2% 0.8% 2.5% - 6.0%

    Pure income (debt) funds, gilt funds, liquid and money market funds do not compare favourably to MIPs mainly because the MIP investor is looking for a monthly return in the form of an income, which other fixed income funds do not provide. And as highlighted in ‘The MIP Flavour – Part 1’, a pure income fund would be hard pressed to distribute dividends on a monthly basis, as it does not invest in equities, like an MIP. Equities can account for up to 15% of the portfolio and act as a kicker for the MIP. To that extent MIPs rely on the equity portion heavily for distributing monthly income.

    MIPs vis-à-vis bank fixed deposits
    Return on FDs are assured, unlike MIPs. So the FD depositor is sure of the bank shelling out the interest amount come rain or sunshine. To that extent an FD (with a monthly income option) scores over MIPs for the very safe investor. Moreover, unlike MIPs, FDs are rated by agencies and this enables the investor to determine his investment avenue that best suits his risk profile. However, while MIPs may not be rated, the discerning investor can check the ratings of the MIP’s investments (be it in bonds, debentures) and determine the MIP of his choice.

    Regardless of other factors, MIPs score over comparable investment avenues in tax efficiency. MIPs are more tax efficient than bank FDs for investors in the highest tax bracket. Income from bank FDs are exempt up to Rs 15,000, beyond which they are taxed depending on the tax bracket of the individual. For an individual in the second tax bracket, income from bank FD is taxed at 22% (20%+10% surcharge) on income beyond Rs 15,000, while for the individual in the highest tax bracket it is 33% (30%+10% surcharge). On the other hand, income from MIP is tax-free in the hands of investors as the fund pays 22% tax.

    So an investor in the second tax bracket is indifferent to an MIP or a bank FD as the tax rate is 22% in both the cases. However for an investor in the highest tax bracket, an MIP is more tax efficient at 22% tax rate vis-à-vis a bank FD at 33% tax rate.

    In an interview to personalfn.com, Mr. Sandesh Kirkire (VP – Fixed Income, Kotak Mutual Fund) opined that mutual funds are most tax efficient and should be the obvious choice for investors from the tax angle.

    What if the MIP fails to deliver?
    If the monthly income is the main draw for an MIP, won’t investors be disillusioned if the fund fails to declare dividends in one month or in several months in succession? Krishnamurthy Vijayan (chief executive officer at JM Mutual Fund), believes they will be. He opined, ‘Yes, investors definitely feel let down if the fund does not declare dividend. This is because investors tend to confuse it with assured returns schemes of UTI.’ However, he believes that the distributor plays an important role by highlighting the difference to the investor.

    But if investors are disillusioned with the MIP, won’t this result in an outflow of funds in favour of say a plain vanilla income fund (with a monthly option) or even a bank FD (again with a monthly option)?

    That’s what we thought given that fact that some MIPs actually failed to declare dividends in July. We posed this question to Nikhil Khattau (CEO Sun F&C MF). He had this to say, ‘Its possible that he may exit from the MIP in favour of a debt fund. However, at the end of the day, he will realise that a MIP offers higher returns vis-à-vis a debt fund, which may make him stay with the MIP.’

    Where do we go from here?
    We asked Nikhil Khattau if MIPs had a future in the country. To this poser he replied, ‘There is definitely a future for these products. MIPs have a lower risk profile since they invest a significant portion of their assets in fixed income securities and a very small portion in equities. MIPs are unlike balanced funds, which invest up to 60% in equities, and are therefore relatively risk-free. The potential for such a product is there, which offers stable returns with the additional incentive of higher returns (should the equity portion do well).’

    Krishnamurthy Vijayan (of JM MF) also echoed these sentiments, ‘People are definitely going to require monthly income plans. There are a whole lot of people who want to save for a rainy day and on retirement they would like a steady income stream. These people will have to be catered to. MIPs are here to stay and there will be such products coming out regularly.’

    So while MIPs may be here to stay, it is not a product for everyone’s palate. The risk profile of an MIP is slightly higher, and for people looking for a stable monthly income, investing in a MIP may involve a slightly higher quantum of risk. At the same time, there are can be no two opinions in the superiority of MIPs in returns and tax efficiency over other investment avenues.



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