Is Current Scenario Conducive for investing in MIPs The year 2011 was a difficult one for investors as two major asset classes, debt and equity, had a tough time throughout the year. On the other hand, fixed deposits offered very attractive interest rates. Moreover, senior citizens were given an additional incentive of around 0.5% by almost all banks. Now that the RBI has hinted a policy reversal, some banks have proactively started lowering the rates on deposits. This would make fixed deposits unattractive for investors. Yes, you are unlikely to earn anything higher than you’d earn last year on your FDs. Investors with low to moderate risk appetite may however have a chance to generate returns in excess of those generated on FDs. Let’s find out ….
A Hybrid Option
MIPs help you to have best of both the worlds, i.e. to say benefits of both debt and equity can be achieved in a single fund. Monthly Income Plans (MIPs) are debt oriented hybrid funds with a small equity component. MIPs generally invest 5% to 25% of its assets in equity and equity related instruments and the balance (i.e 75%) in debt and money market instruments. Should RBI cut the rates; bonds may rally and hence the return from debt funds would improve. Further, a rate cut would make the monetary policy accommodative and may possibly have a positive impact on corporate profits and the stock prices. The equity markets already have been rallying ferociously since the beginning of this year; (this is not to say that equities have been rallying solely for the potential policy reversal). Thus, if equity and debt both are to fare well than what they did last year; a combination of both (i.e. MIP) should prove to be even better.
Structure of MIPs
The structure of this hybrid offering is such that; the core portfolio is made up of debt instruments with a small allocation to stocks. Usually equity component constitutes about 5%-25% of the total assets. Remaining portfolio is spread across various debt instruments such corporate bonds, sovereign debt, floating rate instruments etc. The unique feature of the MIPs is they pay dividend at regular intervals. Although there is no such obligation on them for any such payment (just don’t go by the name ‘monthly income’); under normal circumstances they have rarely missed a dividend so far.
How MIPs will benefit in the current market scenario
As mentioned earlier; RBI may start cutting interest rates from the second half of this year once it gets more clarity on the inflation trend. WPI inflation for the month of January 2012 has been 6.5% which is significantly lower than the 10.9% recorded in April 2010. After staying stubbornly high for nearly 2 years; the inflation has started cooling off. This is partially because of the high base effect and partially due to improved supply of food articles which has brought down the food inflation; a major component of WPI. Besides Inflation, there have been a slew of factors that may force RBI to consider a rate cut which would make MIPs attractive.
While the inflation remained high; economic growth took a beating. As revealed by the tapering IIP growth which has come off sharply from 13% in April 2010 to 1.8% in December 2011. Furthermore, decelerating credit growth and narrowing gap between the credit and the deposit growth points towards the risk aversion of the banks. This is partly because of the deteriorating quality of assets (i.e advances given by banks) and partially because of the tight liquidity condition. As per the data published by RBI; the average daily infusion of LAF was about Rs 47,600 during March 2011-October 2011. However since October 2011 onwards, the system has been facing a cash crunch which is evident from the liquidity deficit, which according to RBI, remains above 1% of Net Demand and Time Liabilities (NDTL) of banks. RBI has taken several measures to curb the liquidity deficit. It has already released around Rs 32,000 crore by a 50 bps cut in CRR and has injected, till date about Rs 70,000 crore through OMO operations. Despite this liquidity infusion, the banks have been borrowing more than Rs 1, 00,000 crore from the LAF. This remains above the RBI’s comfort level of Rs 60,000 crore - 65,000 crore. Sudden depreciation in the Rupee that happened during November 2011 – December 2011 also had a negative impact on the liquidity deficit as RBI intervened to improve the performance of the Indian Rupee. Advance tax payments too had put strain on the liquidity. Considering all these factors, we believe that the rate cut is around the corner. When RBI will cut the interest rates; bond prices would rise and yields will soften. This makes a strong case for investing in MIPs.
Equity markets too have been witnessing turnaround across the globe. Dow Jones, Nikkei have been the outperforming markets amongst the developed world. Taking positive cues from developed markets; India too has done exceptionally well since the beginning of this year. Liquidity injected through Long Term Refinancing Operations (LTRO) in European banking system is flowing all around and emerging markets have not been an exception. Further, US Fed is committed to keep interest rates low till 2014. Back home, the government seems to have set the ball rolling as the process of reforms has been rejuvenated. Early this month, PMO has directed state run coal miner to enter long term Fuel Supply Agreements (FSA) with the companies engaged in power generation business. This is a development that may potentially address the fuel procurement problems of marred power generators. Such initiatives if backed with a progressive monetary policy measures; would encourage international investors to invest in India even more aggressively. Hence equity markets look firm at the moment although any bad news emerging from Europe will drag them down on their knees again.
Things you should know about MIPs
Although debt as an asset class is considered safer than equities; quality of the debt portfolio should not be ignored. Debt instruments are exposed to a default risk. Independent rating agencies rate the debt instruments for their quality. Given below is the table that gives you an idea about the rating profile of MIPs offered by mutual fund houses.
Quality of Debt Portfolio held by MIPs
| Rating |
Max (%) |
Min (%) |
| A & Equivalent |
12.6 |
6.4 |
| AA & Equivalent |
53.7 |
0.6 |
| AAA & Equivalent |
88.1 |
13.9 |
| Cash & Equivalent |
72.0 |
0.6 |
| SOV |
24.8 |
0.7 |
| Unrated |
0.7 |
0.7 |
Note: 46 schemes are considered for analysis; Portfolio as on January 31, 2012 for all the schemes
(Source: ACE MF, PersonalFN Research)
It is clear from the above table that two MIP schemes from different fund houses can be as different as chalk and cheese in asset quality. Allocation to AAA & Equivalent instruments has been in a very diverse range of 13.9% to 88.1%. This would not only affect the quality of the portfolio but may also affect the returns. Instruments enjoying highest quality carry a lower coupon. But as the rating profile deteriorates the borrower usually has to pay higher interest to attract funds. Hence before we look at the returns generated by these schemes we should analyse how the fund manages the trade-off between risk and returns. Risk profile of the same scheme may be different in two different time periods thanks to the flexibility the fund manager has for doing the balancing act. It seems that some fund managers try to play the credit spreads by compromising on the quality while some maintain the quality of the debt portfolio and go aggressive in allocation to equities (which has been in the range of 5%-25%)
Apart from credit profile, it is important to know the average maturity of the debt portfolio. Maturity profile of the portfolio would help us analyse the interest rate risk and the reinvestment risk the fund is exposed to. Long term debt instruments are more sensitive to the interest rate movement than the short to medium term papers.
Maturity Profile of MIPs
| Avg. Maturity of the portfolio |
No of schemes |
| Less than 1 Year |
5 |
| More than 1 year but less than 3 years |
8 |
| More than 3 year but less than 5 years |
11 |
| More than 5 year but less than 10 years |
12 |
| 10 Years and Above |
10 |
Note: 46 schemes are considered for analysis; Portfolio as on January 31, 2012 for all the schemes
(Source: ACE MF, PersonalFN Research)
Looking at the above table, it is clear that the fund managers are divided on the attractiveness of the yield curve. Out of 46 schemes analysed; 10 schemes have an average portfolio maturity of more than 10 years. On the other hand, there are 13 schemes where the average maturity is lower than 3 years. We believe that, at the moment, the yield curve is inverted and short to medium term papers look more attractive than the long term papers. We already have seen the first leg of rally in 10 Year G sec (as yields have softened to about 8.19% on February 17, 2012 from the November 2011 high of close to 9%). We are of the opinion that, hectic government borrowing programme and higher than projected fiscal deficit may keep rates on longer term debt instruments at elevated levels and scope of sharp rally in these papers remains low.
Having said this; it is noteworthy that the fund manager can change the maturity profile of the portfolio anytime by selling the current holdings and buying the securities of desired maturity profile. In other words, the debt component of MIPs functions as a dynamic fund which has flexibility to adjust its exposure across maturities as per the attractiveness of the yield curve.
Finally, we will assess the track record of MIPs to understand their return potential and how much they differ from each other in performance.
How the MIPs have Fared?
Note: 46 schemes are considered for analysis; NAV as on February 17, 2012 Standard Deviation and Sharpe ratio is calculated over a 3-Yr period.
Risk-free rate is assumed to be 6.37%
(Source: ACE MF, PersonalFN Research)
As seen above, as a category, MIPs have outperformed the Crisil MIP Blended Index on 3-Yr and 5-Yr time periods. They have been as much volatile as their benchmark index has been (on par Standard Deviation) but they have failed to outpace their benchmark on risk adjusted returns (Sharpe ratio has been lower than that of their benchmark). Talking about the individual schemes, top 5 schemes have comprehensively outperformed the Crisil MIP Blended Index. This is not to recommend any of these funds but just to identify the quantum of outperformance of the category leaders over the benchmark and the average performance of the category.
A word of caution
Although MIPs are less risky than equity funds; they are riskier than the pure debt funds since they hold a part of their portfolio in equities. Moreover, in debt, they have a flexibility to invest across the maturities and the credit spreads. This essentially makes them a long term product which should be held with a minimum time horizon of 3-5 years like equity oriented funds. Apart from this, one must always keep in mind that; MIPs invest in debt instruments which are tradable in the market and their market value fluctuates which affects the NAV of the funds. Furthermore, volatility in equities too will have its bearing on the NAV of MIPs. Hence investment in MIPs is not risk free and dividends cannot be guaranteed. MIPs usually have a high expense ratio of about 2% on an average which may slowly eat into your returns if the fund fails to perform.
On the monetary policy front, it is unlikely that RBI will immediately cut the rates in its fourth quarter mid policy review. This is mainly because, before it takes such a strong step it should be sure of many a thing such as level of fiscal deficit, which has been the elephant in the room as of now. RBI will get clarity on the fiscal deficit number only once the Union budget in presented on March 16, 2012. We believe that RBI may decide upon the rate cut in its annual policy which will be announced in April 2012. Whether the decision will come in the April itself? It’s probably anybody’s guess as of now.
End Note
After assessing the pros and cons of MIPs; we are of the opinion that one may invest in MIPs but only from the investment perspective and not with the motive of trading. Higher returns shouldn’t come at the cost of portfolio quality. Hence there can be many more things than just the returns for selecting a right fund for you.
This article was written exclusively for Equitymaster, India's leading Independent research initiative. Trusted by over a million members all over the world, Equitymaster is known for its well-researched, unbiased and honest opinions on the Indian Stock Market.
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info@absolut-hund.de
Mar 24, 2012
Depending on your emergency fund (EF) needs, split teewebn the EF and the car loan. But the crux of the matter is not really how to divert your leftover savings, but how to increase those savings to erase your debt burden more quickly.Saving depends on1) Increasing Income (often less feasible).2) Decreasing Expenses (often more feasible).Most people focus on #1, and neglect #2. But most expenses can be decreased dramatically, or even eliminated. Share rent with lots of people, or live at home or in a low-cost area if possible, avoid owning cars in the near future (they suck a lot of money), eat out less, buy less (or better yet, nothing) or secondhand, don't engage in expensive sports/hobbies, no travel/tech gadgets/brand names/movies, etc. Reduce all water, power, phone, mobile + cable bills to the minimum. Analyze your biggest expenses (usually rent/car/food/leisure/bills), and find ways to cut all the financial fat. Since you'll have a lot of extra time on your hands, use it to invest in educating yourself and developing your professional talents/interests/skills so that you can achieve a higher future income potential. Go DIY don't pay others to teach you.Live poor because actually, you ARE poor. By my personal definition, if you need a job in order to feed yourself, you're poor. If you need to worry about what your boss thinks of you, you're poor. If you're in debt, you're in the hole poor. Don't be generous or ashamed you literally can't afford to be. Be generous and proud after you've saved up some $ $ $ . Extreme situations call for extreme measures. If you compare yourself to other people with lots of debt, you'll feel your situation isn't so bad, but you should be comparing yourself to people with positive net worth. I only make 18K/year now, but I save about 10,12K more than 50% savings on income. I've been doing this for many years now, so it all adds up. So despite my low income, I had my basic 1K EF in my first month. I intentionally chose to live in a lower-cost city that didn't require a car, and in the beginning I had to forego a lot of costly urban enjoyments (movies, dining, shopping, etc.). But the payoffs have been tremendous; I don't worry about money or jobs. Plus, I only work part-time now. If you can find a way to save 1K a month, you'll be well on your way. It'll only take 20 months to pay off all your debts. If you have higher income and can save 1.5K, you only need 13 months to be completely debt-free.After you pay off your debts, you should continue your hardcore saving for a couple years, (1yr =12K, 2y=24K, 3y = 36K, depends on what your long-term financial goals are), after which you can invest your savings, and your money can start working for you, instead of you always working for money. Then you can ease off on or abandon the Spartan lifestyle. If you're a guy, you might not want to though, because being a Spartan is actually pretty cool. It's good mental physical training, because it helps to cut away all the consumer materialist crap in life. Makes you focus on what's really important in life which is ironically, not the money, but yourself, your relationships, and your purpose in life. And coincidentally, all those 3 things suffer when you're working the 9-to-5 grind and spending nearly all of your hard-earned money on whatever. Best wishes to you - |
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