Recently, we met a rather hassled investor. His concern was that his Monthly Income Plan (MIP) had skipped dividends over the last few months. As a result, the investor was in two minds about the prospects of the MIP and wasn't sure if he should stay invested.

Before discussing the case further, first let's understand the investment proposition offered by MIPs. MIPs are hybrid investment avenues that invest a minor portion of their portfolio (around 15 per cent-25 per cent) in equities and the balance in debt and money market instruments.

Typically, MIPs are suited for investors with a low-moderate risk appetite. For instance, investors who wish to clock higher returns than those offered by fixed deposits or bonds and are willing to take on commensurately higher risk should consider adding MIPs to their portfolios.

Also MIPs appeal to investors in higher tax brackets for their ability to deliver more competitive post-tax returns vis-�-vis avenues like fixed deposits.

As the name suggests, an MIP aims to provide investors with liquidity by regularly declaring dividends; it is not uncommon for investors to opt for the monthly dividend option. However, it should be understood that dividends are not assured.

MIPs being market-linked avenues, dividends are declared subject to the availability of a distributable surplus and at the discretion of the fund house.

Sadly, MIPs have been the subject of much mis-selling over the years. Often, MIPs are projected as investment avenues offering assured monthly returns.

While in conducive markets (when fund houses declare dividends regularly) all seems fine, it is in testing market conditions that MIPs skip dividends leading investors (especially victims of mis-selling) to panic.

The investor in question fell in this category as well; he was 'assured' by his investment advisor of an assured income month-on-month at the time of investment.

Investors desirous of receiving an assured monthly income should opt for avenues like the Post Office Monthly Income Scheme (POMIS) or fixed deposits with the monthly interest payout option rather than MIPs.

Conversely, those investing in MIPs should be unambiguously aware of the possibility of not receiving a dividend payout every month.

Small Savings Schemes: An overview

Speaking of dividends, investors are known to make investment decisions based on an MIP's dividend history. The rationale being that the dividends declared are correlated with the fund's performance. Hence a fund that doesn't skip a dividend is seen as a good buy.

However, this need not always hold true. Sure, while MIPs that perform well are expected to declare dividends regularly, there can be occasions when even the opposite holds true.

For instance, it is not entirely uncommon for some fund houses to declare dividends even in testing market conditions. They can do so by maintaining a healthy reserve position and declaring a nominal dividend. The underlying intention is to achieve an unblemished track record as far as declaring dividends is concerned. The same can be flaunted as a sales pitch to accumulate fresh monies from investors.

Is the dividend option in an NFO a smarter choice?

On the other hand, there could be funds that choose to react differently in the same situation. For example, in times of market volatility, some MIPs might choose to skip dividends and instead utilise the available reserves to invest at attractive valuations.

While then investors might rue the fact that they missed out on a dividend, over longer time frames, the MIP's strategy (to invest rather than declare dividends) can hold them in good stead. Clearly, the fund house's investment philosophy has a bearing on its dividend declaration policy.

What should investors do?

1. For starters, they need to determine if the MIP is an apt investment avenue in their portfolios. If an assured monthly return is what they seek, there is a case for exploring other options.

2. Having decided on the MIP, the next step is to select the right one based on a variety of factors ranging from the fund house, the MIP's investment style to its track record, among others.

3. While the dividend history needs to be considered, it certainly can't be the only parameter to base an investment decision on or a parameter to be considered in isolation.

4. Finally, in times when an MIP chooses to skip a dividend, investors would do well to explore the reasons behind the same. The investment advisor has an important role to play at this stage.