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PERSONAL FINANCE: INCOME FUNDS

The Thing About MIPs

An MIP doesn't assure returns. But if you can do without a monthly dividend or two, your average returns in the long-run will be reasonable.

By  Roshni Jayakar

The Thing About MIPsSun F&C Monthly Income Plan has, as a result of the fall in both equity and debt markets, seen nav fall from Rs 10.01 at the beginning of the month to Rs 9.70 on July 25, 2000. As a result of this, we have been unable to declare a dividend on the scheme for the month of July, 2000.
Extract from Sun F&C Asset Management CEO Nikhil Khattau's note to investors.

The NAV of Templeton MIP declined by 0.08 paise and the NAV as on July 24, 2000, stands at Rs 10. Therefore, due to lack of distributable profits, the fund will be unable to pay any dividend for the month of July.
Extract from Templeton Asset Management CEO & Country Head Rajiv Vij's note to investors.

The mail brought bad news in August. Dear John type letters from two of the country's best-known funds shattered the belief (prevalent among investors) that Monthly Income Plan schemes (MIPs) were safe investments that promised assured returns. Till the early August missives from Sun F&C and Templeton, they were: while returns from income funds hovered in the 10.08 per cent region, those from MIPs ranged around 14.09 per cent. Then, Templeton and Sun F&C went and skipped monthly pay-outs and investors grew cold towards the entire genre of MIPs. After all, if an MIP does not pay a monthly dividend, conventional investment-logic states there is no reason to stay invested in it. Conventional investment-logic sucks. An MIP doesn't assure returns; and if you, dear investor, can do without a monthly dividend or two, your average return over the year is certain to be respectable.

Why MIPs Missed Out in July

The reason for a dividend-less July lies in the battering the two-monthly income schemes (and other schemes) received at the hands of the debt and equity markets. Most MIPs invest up to 15 per cent of the funds they manage in equity, and the rest in debt. ''The equity portion,'' explains Milind Nandurkar, 32, Fund Manager, Sun F&C, ''gives a better return in the medium term than a pure debt scheme would.'' And the debt portion generates a steady return.

In July, 2000, though, the Reserve Bank of India upped the Bank Rate by 1 per cent. The increase in interest rate was unexpected and fund managers were caught with a debt portfolio with a not-insignificant maturity profile (when fund managers expect a hike in the market rate of interest, they try and substitute long-term debt with short-term government securities so as to reduce the maturity profile of the portfolio-getting the yield-curve to move down). This caused the yield-curve to move up and reduced the value of the debt portfolios.

Nor were the equity markets kinder: the Sensex dropped by close to 600 points in July, effectively wiping out, in the case of MIPs, the return earned by the 85 per cent debt component. The result of this double-whammy? The Net Asset Values (NAVs) of most MIPs crashed. This, despite some of the funds in question, like Sun f&c Asset Management, reducing their equity exposure and pro-actively pruning the maturity profile of their debt portfolio. The end result of this D-W? Sun F&C MIPs and Templeton Mutual Fund MIPs skipped pay-outs, and Alliance Capital MIP slashed its from 10 paise a unit to 9 paise.

How to Live with MIPs

Yes, we know the Unit Trust of India's MIP offers investors assured returns for a year. But the UTI doesn't fall under the purview of the Securities and Exchange Board of India (SEBI); all other funds do. Ergo, they have to adhere to the regulation of not guaranteeing a certain quantum of returns. Indeed, the fine-print in most offer documents for MIPs carry a disclaimer to that effect: ''The mutual fund does not guarantee or assure a monthly or quarterly dividend. The fund also does not assure investors that it will make monthly or quarterly dividend distribution, though it has every intention of doing so. All dividend distribution is subject to the investment performance of the schemes.''

Are the UTI's MIPs better? Not really: while the returns on other MIPs are between 10 per cent and 12 per cent, that on the UTI's MIP 2000 (3rd scheme) is 9.75 per cent (assured for a year). ''Besides,'' says Nilesh Shah, 33, Fund Manager, Templeton Mutual Fund, ''with interest rates headed north, we could benefit from higher yields in the debt market.'' If you invest in UTI's MIP, though, you won't.

Who Should Opt for MIPs

Monthly income plans are just right for investors who are ready to stick it out for at least a year, and whose cash flows won't be hit by a skipped pay-out or two. Consider the Alliance Capital MIP. The scheme had declared a 2.5 per cent dividend in the first month of its operation (October, 1999). This was followed by 1 per cent every month, till July, 2000, except April, 2000, when it declared a whopping dividend of 11 per cent. The annualised rate of return on the MIP if one were to average out payments over the nine months of the scheme's existence? 22 per cent.

If you decide to put your money in an MIP, you should remember that all the MIPs invest some part of their funds in debt. That means they fork out a 22 per cent tax on their income distributed as dividend.

The smart choice is to opt for an MIP with a growth option and a Systematic Withdrawal Plan (SWP). You could, for instance, invest Rs 1 lakh in such a scheme and opt to receive Rs 1,000 a month after a year. This quantum (Rs 1,000) is your systematic withdrawal amount, and the number of units in your account (say 10,000 assuming an offer-price of Rs 10) will come down by a number that is a function of the SWA and the NAV of the unit on the redemption date.

Thus, if the NAV of the unit on the redemption date is Rs 12, a total of 83 units (1,000/12) will be redeemed that month. The exercise goes on till you exhaust your account (all 10,000 units are redeemed). And you pay a long-term capital gains tax of 10 per cent on the units redeemed.

Last word? Stay with the MIPs; they are certain to pay back in the long-term.

 

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