MIP - Is this India's most misleading mutual fund product?

I feel that the financial product with the most misleading moniker is the ‘Monthly Income Plan (MIP)’ offered by mutual funds. The nomenclature suggests that these schemes assure some income to their unit holders every month but this is far from reality. Many of these schemes not only declare dividend at irregular intervals, even the quantum of dividend declared each time varies widely. A bigger irony is that most MIPs offer a “Growth” option too, something which is anachronistic, to say the least. In a nutshell, “True-to-label” MIPs are more the exception than the rule.

These funds most closely resemble ‘debt-oriented’ balanced funds. They invest around 15-20% of their corpus in equities and the remaining in fixed income instruments. This means that unit holders are not only exposed to NAV related risk, their primary objective of earning a monthly income too may not be met in the months where the fund suffers heavy mark-to-market losses. Given that fluctuations in the equity market are usually several times that in the debt market, a smaller proportion of equities may not necessarily serve as any measure of capital protection. However, they have an advantage on the tax front vis-à-vis other fixed income options, as unlike interest income which is taxed as per one’s income tax slab, the dividend distribution tax (currently, at 12.50 % but slated to rise to 25% from June 1, 2013) levied is lower than the income tax slab of most investors. Besides, long term capital gains too are charged at a concessional rate.

I think that such funds fall in between two stools. Not only do they fail to protect capital, unlike regular equity oriented balanced funds they do not participate much in the upside too given their relatively low equity allocation. I think such funds are best suited as a vehicle for introducing hard-core fixed income investors into the equity market. Once they get a flavor of these funds they can move on to other equity oriented options such as regular balanced funds and diversified equity funds.

Finally, until the Regulator decrees that such funds rename themselves it is the duty of advisors to present the correct picture so that investors know what they are getting into...