Monthly Income Plans: New flavour of the season!

In the current economic cycle, it is highly likely that the interest rates could tend to fall and that will in turn mean that bond prices will start to increase. This scenario is well positioned for Monthly income plans {MIPs} (which invest almost 75%- 90% in debt instrument) to deliver impressive returns as the interest rates are expected to moderate going forward.

Monthly Income Plans are a good option for risk averse investors who are looking for a higher return and a more liquid alternative to Fixed Deposits. MIPs are lesser known avenues within the broad debt ambit but could be an ideal option for investors who are looking for good returns with moderate risk.

Monthly Income plans

These are open-ended schemes that invest a majority of their assets in fixed income instruments and a small allocation to equity and equity-related instruments. This category of fund aims to provide a regular income to the investor. An MIP typically invests the bulk of its assets in debt, while a small equity exposure is maintained to earn something extra. Generally, the equity allocation is capped between 10% and 25% of the total assets. This option is open for those investors’ who are looking at regular and steady income and still want to dabble a bit in equities.

Monthly Income plans offer options of monthly and quarterly income. Neither the frequency nor the volume of the dividend is guaranteed. The investments made by these schemes bear market or interest rate risks and move with their respective benchmarks; at times, when the markets remain volatile with a downward bias, the fund manager may even choose to skip the monthly dividend. With the fixed income component dominating, these plans do not suffer much on the downside.

Like all other mutual funds, MIPs too come with the Growth & Dividend (Payout and Re-investment) option. The 'Growth' option of an MIP is ideal for a ‘Moderate’ risk profile, since it typically falls between a pure income fund and a balanced fund. It is a viable option for HNIs, Institutions, Trusts etc. as these investors typically do not require a regular monthly dividend inflow, but still would offer capital appreciation at controlled risk levels.

The other option of Dividends will offer regular payouts which will essentially assume the form of a monthly income. Dividends declared under MIPs are tax-free and therefore MIPs are more tax efficient than FDs. Income from bank FDs is taxable as "income from other sources" and is taxed depending on the tax bracket of the individual.

If you sell the fund units before a year and there is a gain, short-term capital gains (STCG) tax is applicable - the net gain will be added to current taxable income and tax will be levied as per normal tax rates. If you sell units after a year and there is a gain, a long-term capital gains (LTCG) tax is applicable - 10% tax will be levied (without indexation benefit) or 20% tax with indexation benefit, whichever is lower.

Returns

It is important to evaluate the fund before investing; one also needs to compare across Monthly income plans which have the same equity exposure. In the below case, Birla SL MIP has ~24% equity exposure while Magnum MIP has ~19% equity exposure and hence, the returns can vary starkly.

 
Risk Analysis

Risk – Associated with debt assets in the portfolio: MIPs are affected by interest rate changes in the economy as explained below:               

When interest rates (in the economy) fall: NAV of MIPs rises (due to increase in bond prices);
When interest rates rise (as in the current scenario): NAV of MIPs fall; this is when MIPs look to the equity portion in the portfolio to sustain returns.

Suitability

MIPs are suitable for an investor who is conservative, but would want to gain some exposure to equity. With many individuals looking at fixed deposits as an investment option, they could evaluate monthly income plans which would provide better returns in the long run and are also relatively tax efficient. It may also suit a senior citizen or some individual who is closer to retirement.

Budget Impact

In order to provide uniform taxation for all types of funds, other than equity oriented funds, the Government has increased the surcharge from 5% to 10%. The Budget also proposed increase in the rate on distributed income from 12.5% to 25% in all cases where distribution is made to an individual or an HUF. This will impact the net returns on dividend schemes of all debt mutual fund schemes.

 Summary –
•    Suitable for current environment as interest rates will moderate in the short – medium term
•    Provides upside at controlled risk; equity exposure is capped
•    Conservative investors / Senior Citizens can avail this option
•    Tax efficiency and returns help MIPs score over other debt instruments like Fixed Deposits


Anil Rego is the CEO and founder of Right Horizons, an end-to-end Investment advisory and wealth management firm.

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