Sunday, August 21, 2011

[www.keralites.net] Income Funds an alternative to Post Office Monthly Income Scheme

 

Though the income generated from Post Office Monthly Income Scheme is guaranteed @ 8% p.a  plus 5% capital appreciation after a period of six years, the Income Funds offered by Mutual Funds are an alternative to this.  As per SEBI rules Mutual Funds can't assure any regular return or capital appreciation, some of the Mutual Funds are potential  enough to provide a return and capital appreciation at par or even better than the  PO MIS.  The only advantage of PO MIS is its future stream of incomes and capital you invested are assured and guaranteed by government of India but Mutual Fund Schemes lacks this guarantee.
 
The minimum amount required to start an income fund is as low as Rs. 5,000.00. The facility of   systematic investment plan also available. The ideal time frame for investments in an income fund is two-five years. Though income funds do not charge an entry load, there is an exit load in place if exist from the scheme within certain period of time. Normally funds are offering two options one growth and other dividends.   Investors looking for regular income should opt for the dividend option. The growth option is meant for investors looking for a capital appreciation and they don't require a regular stream of income.
 
As we are aware Reserve Bank of India recently hiked the bank rates by 0.50% (50 basis points).  This is definitely going to increase the interest rates both deposits and borrowings.  When interest rates raising it is advisable to invest in income funds.  There is an inverse relation between interest rates and bond prices.  When interest rates go up bond price will come down likewise when interest rates come down the bond prices will go up.  When interest rates come down, it is advantages for the existing investors in the income funds because the bond prices will start increases, accordingly the NAVs of income funds will move up correspondingly.
 
Let me explain what an income fund is.  An income fund is an open-ended mutual fund scheme that mainly invests in debt securities or otherwise called fixed-income generating instruments    of varying maturities to generate continuous income from the coupon or interest payouts of the   instruments. The fund also invests in certificates of deposit, commercial papers, government bonds, debentures and securitized debt to build a diversified portfolio offering good risk –adjusted   returns.   The liquidity of the fund is mostly managed by way investing in call money market, treasury bills and collateralized borrowing and lending obligations.  The quality of the portfolio is mainly depending upon what type of instruments which the fund manager selected for the investments.  If the fund manager opted to investment in low rated financial instruments that will affect the quality of the portfolio, which will increase the chance of default.   Low rated (like below investment grade) bonds or financial instruments will provide 3-5% higher rate of interest when compared to the high rated bonds, but it's risky, there is a greater chance of losing the principal as well there is no guarantee that, these instruments will provide an interpreted stream of income as promised.   Normally the instruments which the fund managers propose to be invested will be mentioned in the fund offer document itself.  So one must see the quality or the credit rating of the financial instruments in the portfolio before investing in.  Otherwise the investment in income funds will be more risky than investing in equity funds.  Some income funds invest 5-10% of its portfolio values in selected low risk dividend paying equities also.  This will provide the funds an opportunity to earn capital appreciation or a steady growth. The fund manager of an income fund does his best to strike a balance between the credit rating and yield of the portfolio.  As I mentioned earlier, capital appreciations are a function of interest rate changes. If the interest rates were to move up, the fixed income instruments, especially those with longer maturities, see a fall in price. This, in turn, results in a capital loss and a lower net asset value (NAV) of the fund.
 
The returns payable by funds are influenced due to changes in interest rates. The returns generated by an income fund include both the coupon/interest payments and capital appreciation. Higher the coupon – the rate at which interest is paid by the borrower — higher the income for the investor. Also, the higher the coupon, the lower the credit rating of the bond, other things remaining the same.  One have to be very careful in selecting a good income fund, if you select a wrong fund there is a likely chance of not meeting your investment objectives both in regular income as well as the capital you invested in.  So please take the help of a good financial planner to select a good mutual fund income scheme for you those suites your income expectations and risk appetites.  Those who don't wish to take any risk can opt for Post Office Monthly Income Scheme; the maximum amount one can invest in POMIS singly is 4.5 lakh and 9.00 lakhs jointly. 
 
Please avoid investing in Monthly Income Schemes of Insurance companies.
 
The following are some of the good performing Mutual Fund Income Schemes
Fund Name                          one year return as on 18/08/2011
SBI Dynamic Bond                         9.57%
UTI Bond Fund                               9.27%
Regligare Income Fund Plan A        8.81%
IDFC Dynamic Bond Plan B            8.80%    
L&T Select Income-Flexi DI            8.53%
 
With Best Regards
 
Prakash Nair

www.keralites.net   

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