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Long-term bonds may rally soon as rates are likely to be lowered. MIPs can return up to 12% if equities also join the party
Monthly income plans, or MIPs as they are popularly known, are in bad shape. According to Value Research, an independent mutual fund tracking agency, mutual funds in the hybrid-debt-oriented conservative category, under which most MIPs fall, delivered an average returns of 3.03% in the past year.
The weak performance by these schemes can be primarily attributed to the fall in the stock markets, as all these schemes have some exposure to equities. But, hereon, these schemes can deliver for an investor with an investment horizon of at least two years. He is not alone. Many other experts also say investing in MIPs now can be a good bet in the long run.
Why MIP ?
MIP is a marginal equity product, which works for conservative investors who are comfortable investing a small component of their money in equity. By investing a very small portion of the investment in stocks and the rest in high-quality fixed income instruments, MIPs mostly limit the downside. They further offer an opportunity to participate in the upside when equities rally.
MIP is a good solution for those who cannot invest in two different schemes – a bond fund and an equity fund — on their own and rebalance their portfolio regularly. MIP not only gets the asset mix right but also rebalances the portfolio from time to time.
Dividend payouts are not guaranteed, but fund houses make it a point to maintain consistency in dividend distribution so that investors can use MIP to cater to their income needs, too. But the schemes will deliver only if the macro-economic environment is right.
There is good news on the debt front. The recent monetary policy of the Reserve Bank of India offered ample hints that things on the macro-economic front are falling in place. The central bank has maintained status quo on policy rates. This is a clear signal for fixed income investors looking to put their money in long-term papers to lock in yields and sit peacefully.
Over the past year, rising interest rates made most fund managers invest mostly in short term papers since the prices of long-term bonds fall when rates rise. If inflation were to come down as projected by the RBI, there is a fair possibility of a rate cut over the next year, which would mean better returns from long-term papers. Since MIPs have most of their money in fixed income instruments, they would benefit from such a scenario.
However, the party could be spoiled by equities, which have moved south over the past year. The S&P CNX Nifty has lost 20% in a year. Experts think most of the negatives are priced into equities. The current valuations enjoyed by equities are decent and can add a kicker to returns offered by MIPs. An investor with two to three-year horizon can reasonably expect 10% to 12% annualised returns.
Risks
Though the time is ripe for investment in MIP, one should never blindly commit money to such schemes. There are risks involved, which can result in suboptimal returns, as highlighted by the recent poor performance of MIPs. The risks are primarily due to the equity component, which could range from 5% to 25% in an MIP portfolio. Take, for example, a scheme that invests 75% of its money in fixed income investments and the remaining in equities. Now, say, the fixed income investments deliver 10% returns over a year and that the equities component loses 10%. The scheme as a whole would have, therefore, delivered just 5% returns. If you deduct the expense ratio of 2.5%, you are left with just 2.5% as returns for an entire year.
The fixed income portfolio of an MIP is also not completely safe. Though the fund manager invests in highly-rated instruments to minimise credit risk, many fixed income portfolios face interest rate risk. In a rising interest rate scenario, a fixed income portfolio comprising long term bonds will offer lower returns, as bond prices will fall
Fixed income as an asset class looks set to be in for good times and equity valuations also appear attractive, but don't jump in to invest in MIPs. First, ascertain your risk-taking ability and your returns expectations.
If you are a conservative investor and expect returns of 9% to 10% over one or two years, then you would be better off investing in schemes that restrict their exposure to equity to 5%. If equities see a rally in the interim period, you can expect higher returns. If you can stomach volatility, then you can look at MIPs with 25% equity exposure. These schemes may be volatile in the short term, but can help you pocket double digit returns over the next couple of years.
Savvy investors can further boost their returns by looking at the fixed income portfolio of an MIP. Invest in the long-term plan of an MIP or look at MIPs with fixed income portfolios with high average maturity to benefit from a possible rate cut next year. As interest rates come down over the next couple of years, one can pocket annualised returns of 12% to 13.
In such schemes, returns will come from two components in the fixed income portfolio — the periodic coupon received by bonds and, secondly, capital appreciation from a rise in bond price when interest rates fall. A word of caution: such funds can be volatile in the short-term. If inflation does not come down in a secular manner and there are spikes in between, the long-term bond yields may soar, leading to a fall in bond prices, and, ultimately, putting pressure on the returns from an MIP portfolio.
If you are a long-term conservative investor looking to invest some of your money in equities and allocate most of it to fixed-income instruments, then opt for the growth option of an MIP. If, on the other hand, you are looking for regular income, then choose the dividend option. You can opt for monthly, quarterly, or yearly dividends, depending on your needs.
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