5-Step investment strategy for investing in MIPs

In the present world of financial innovation and exuberance, it is quite difficult for an investor to make the right choice. Unfortunately most of the advisors, relationship managers or agents are driven by commissions and thus do not give much importance to the interest of the investors while selling financial products. In such a scenario, investors seek solace in simple yet effective financial products. One such product from the mutual fund industry is the Monthly Income Plan (MIP). It is noteworthy that "MIPs do not assure monthly income": Yes, even though the MIPs (from various mutual funds houses) have been fancily named as "Monthly Income Plans"; they do not assure any monthly income for investors.

MIPs are debt oriented hybrid funds with a small equity component. MIPs generally invest 0% to 25% of its assets in equity and equity related instruments and the balance (i.e. 75%) in debt and money market instruments. So, a major portion of their portfolio earns stable income from the coupon payments, thus providing safety and stability; the small portion of equity on the other hand, adds a zing to the overall portfolio by enabling the fund to benefit from capital appreciation and of course earn dividends from its stock holding. But a noteworthy point is, during the downside of the equity markets an MIP can take toll on the returns front; and this especially is true in the case of a MIP having exposure to the equity which is on a higher side. Hence broadly, MIPs serve as a dual purpose of safety as well as an ability to earn higher returns through the equity push.

Thus, in order to make investing in MIPs an easy affair, we present investors with a 5-step strategy for investing in the MIP segment.

1. No assured returns
Investors would do well after understanding that investments in MIPs don't offer assured returns. The seemingly deceptive name i.e. monthly income has done a huge disservice to the segment. Investment advisors were at times guilty of peddling schemes to gullible investors under the guise that their investments would yield assured returns. Nothing could be farther from the truth. MIP offerings from mutual funds shouldn't be confused with the Post Office Monthly Income Scheme (POMIS) from the small savings segment which offers assured returns. And even if an investor opts for the dividend option, the MIPs are not mandated to declare dividends on a regular basis. Dividends in MIPs are declared only if there is adequate surplus generated by the fund to declare the same.

2. A higher equity component doesn't make the fund better
Another common misconception is that a higher equity component makes the offering a better one. MIPs offer an equity component ranging from 5% to 25%. In fact, the wide choice available is one of the biggest advantages of the segment. Investors can select a variant that best fits into their portfolio and matches their risk profile. While a higher equity component can aid the fund in offering higher returns, the same can also enhance the MIP's risk profile. So, investors need to be careful before they opt amongst MIPs based on their equity component.

3. Check the debt portfolio's average maturity
The present interest rate scenario wherein the interest rates are about to ease albeit gradually, has made investments in debt instruments rather attractive. As a result, fund managers have shown a marked preference for instruments with a low to medium maturity profile. Such instruments are less susceptible to volatility in the markets and hence, are better equipped to offer a degree of stability to the fund. Moreover, it is also important to gauge one’s investment horizon and ideally it should match with the average maturity of the debt portfolio of an MIP. Thus, an investor having an investment horizon of three years then ideally the debt portfolio’s average maturity should be around two to three years.

4. Examine the quality of the MIP’s debt portfolio
MIP is a pre-dominantly debt offering, hence the debt portfolio's composition would have a significant bearing on the fund's performances. The debt instruments credit rating is of utmost importance. A portfolio dominated by AAA/similar rated instruments (which indicate the highest degree of safety) would be indicative of the fund manager's intentions of not taking on too much risk. Conversely, a lower rated portfolio would point towards the intent of clocking higher returns by taking on commensurate risk. Thus, depending on one’s risk taking ability, an investor should opt for a suitable MIP.

5. Dividend option
It is not mandatory to go in for a dividend option under a MIP; an investor can also opt for growth option. However, if the intention is to have some cash flows then a dividend option can be opted. Here again it would be prudent to adopt a quarterly dividend option as this gives the fund manager more breathing space as compared to the monthly dividend option. As a result, the probability of receiving a dividend under a quarterly option is much higher even in tough market conditions (where the quantum of dividend declared may be reduced). Hence investors should ideally opt for the quarterly dividend option.

PersonalFN is a Mumbai based Financial Planning and Mutual Fund Research Firm