Wednesday, January 28, 2009

Monthly Income Plan: Sound investment

Those with a low-risk appetite who want an 'equity icing' can go in for MIPs. Any savings instrument that contains equity has turned sour for investors following the 2008 markets crash. But there is one mutual fund product, Monthly Income Plan (MIP), launched in 2000, which has held on despite having exposure to equities.Although MIPs have posted negative returns both in nominal and real terms, experts reiterate a reconsideration of the offering as an investment option.

What are MIPs?
These funds were launched with the objective of providing regular income to the investor. Dividends, if any, were paid out of investment profits at periodic intervals - monthly, quarterly or half-yearly. The regular income objective could be achieved by investing at least 75% of the assets in good quality fixed-income instruments and the rest in equities. The less-risky funds restricted equity exposure to 10% of the assets.


Who should invest?
MIPs' target segment includes retired people or those nearing retirement. The offering could be a good solution for those who want to invest in safer assets and still want some 'equity icing'. The risk profile of these funds places them in the space between income and balanced funds, which in turn attract those with low-risk appetite. Those who prefer to have low-risk investment and still want to participate in an upside, if any, may consider investing into an MIP.

What does one expect?
In an age of turbulence, most of us are not sure where equity will head. Though most experts reckon that equities are quoting at bargain prices, it is difficult to go for them. In such circumstances, MIPs can emerge as a preferred means of getting equity exposure. In a falling interest rate environment, MIPs could deliver good returns going forward.



Possible adversities:
Only a few offerings in the market have maintained consistency in paying dividends. The pressure to deliver regular returns means that fund managers cannot take any long-term bet, and hence, the participation in upside remains limited. A postal monthly income scheme, which offers guaranteed returns, scores over MIPs when returns are uncertain.The fixed-income investments carry credit and interest rate risk. Fund managers are pressurised to perform in both the asset classes - equity and fixed income - which, in classical sense, are expected to move in opposite direction.Being on the right side matters. The extent of equity exposure a fund is allowed to take and active management of equity exposure primarily decides the excess returns generated by the fund. A 10% cap on equity exposure may appeal to investors because of the limited downside seen during bad times. But, the same would appear as a dampener as markets recover. There is a set of investors who would prefer to keep things simple by buying into a diversified equity fund and an income fund, where the proportion of investment in each is decided by the investor and the investor can enjoy the best of both the offerings.

Caveat emptor ::: LIC Jeevan Aastha

Is the phenomenal response to the Life Insurance Corporation’s (LIC) Jeevan Aastha scheme (that closed on Wednesday) a tribute to the life insurance
behemoth’s cleverness in structuring a winning product? Or is it — collections are estimated to cross Rs 8,000 crore — more a reflection of some smart, and not-so-transparent, selling by LIC? The answer is a bit of both. LIC certainly demonstrated an uncanny ability to assess the pulse of the market right, designing an assured returns product that seems tailor-made for uncertain times. But much of the success of the scheme is because LIC was less-than-fully transparent about the benefits. Unfortunately, the insurance regulator, IRDA, too, seems to have turned a Nelson’s eye to the not-so-subtle mis-selling going on right under its nose. Prima facie, Jeevan Aastha is a single premium assurance plan with guaranteed benefits on death or maturity. In an environment where banks have reduced interest rates on fixed deposits (FDs), it seemed to offer the best of both worlds — a higher (tax-free) return than FDs and insurance cover as well. Not surprisingly, it met with a huge response, though a careful calculation shows returns are likely to be much less — in the range of 6.75% to 7.25% per annum in most cases! This paper has often argued the need for greater financial literacy on the part of investors (and greater transparency on the part of players). Even so it is doubtful many investors, even those who are fairly clued-in, would have been able to pierce the veil behind LIC’s complicated ‘benefit illustration’. For instance, insurance proceeds are normally tax-free. But if the premium payable on any insurance plan exceeds 20% of the sum assured, the proceeds become fully taxable. In the case of Jeevan Aastha, the single premium is often likely to be more than 20% of the maturity proceeds rendering the maturity amount taxable. However, LIC chose not to disclose this. Caveat emptor must be the guiding principle especially where money is involved. Nevertheless, it is high time financial players stopped playing a cat-and-mouse game with investors, counting on their naiveté to garner funds. Where they do not, the regulators must step in and compel them to do so.

Refinance window open till September

The Reserve Bank of India (RBI) On Tuesday extended the tenure for two refinance facilities, including one to provide support to mutual funds and finance companies, for banks by three months to September 2009, though the use of both windows remains minimal.
Soon after the collapse of Lehman Brothers in the US in September, the global financial market freezed and liquidity dried up from the markets. The effects were also seen India.
The central bank had opened refinance windows to ensure that mutual funds and non-banking finance companies (NBFCs) in India get adequate resource support to meet redemption pressure and are able to conduct normal operations. Later, the housing finance companies were also allowed to use this facility
Now, there is adequate liquidity in the system and funds are available due to a slew of steps, including a 400-basis-point cut in the cash reserve ratio. The actions of the Reserve Bank since mid-September 2008 have resulted in an augmentation of actual/potential liquidity of over Rs 3,88,000 crore.
A senior Bank of Baroda official said that currently there was no demand from mutual funds as they do not face redemption pressure. In the early part of the third quarter (October), MFs were facing liquidity problems due to a sudden rise in redemptions, immediately after the collapse of Lehman Brothers.
Under the first refinance facility, RBI provides assistance through repo window up to Rs 60,000 crore on an outstanding basis. Banks can avail additional liquidity support of up to 1.5 per cent of their net deposit liabilities only for lending to MFs, HFC and finance companies. Banks can still use eligible securities worth Rs 59,170 crore to draw funds under refinance facility, indicating very low usage of facility.