What do you think when you see the giant ads promising you the highest net asset value (NAV) in a unit-linked insurance plan (Ulip)? Most of us would believe that we’d get the highest possible return with zero risk.
But knowing, as you do too, that nothing comes for free, we put all the products that are guaranteeing NAVs under scanner. The quick conclusion: your returns will be between 6% and 15% in the long term. Shave off another 3% for cost and suddenly the guarantee looks a bit weak.
Essentially, these are capital guarantee products that ensure that the amount you invest does not lose value and you get some upside of equity. It is erroneous to think that you get Sensex-linked return, with zero risk. Ashwani Gujral, chief market strategist, Ashwanigujral.com, a stocks investment advisory portal, says: “These funds can’t guarantee the pure return of an equity fund. To guarantee returns on equity, you need to assume the risk on equity.”
Let’s understand how these funds work. Most of them use an investing strategy called dynamic hedging or constant proportion portfolio insurance (CPPI). Under this, the fund manager will constantly reallocate money between debt and equity classes to assure the previous highest NAV.
In year one, your investment will be split between debt and equity in such a manner that you get an assured NAV of Rs10 at the end of 10 years. Over the year, if the equity market goes down, your capital stays put as you have bonds. But if the market goes up, you will see the NAV rising. So, let’s say, we are at an NAV of Rs15 after a year and the market sinks 15%. The fund manager will sell equity and buy bonds to secure the highest NAV till then.
In a market that has no volatility, the product will work because the NAV will go up only in a linear manner. But real life is less neat. Each time the market falls and your allocation in debt rises, the reverse allocation to equity may not happen when markets recover. Remember, the debt part of your portfolio is holding bonds that ensure the highest NAV at maturity. So over a period of time, your portfolio in equity may become smaller and smaller and would move towards a pure debt fund.
Also See High Costs (Graphics)
Says Shashi Krishnan, chief investment officer, Bajaj Allianz Life Insurance Co. Ltd: “Depending on how much the markets fall, and at what point during the tenure, we reserve the right to exit the stock market and keep all the money in debt.” Given the “go-anywhere” mandate—or 0-100% allocation in equity, debt and money market instruments—that the policy document allows, these funds can technically move fully into debt and stay there, making your Sensex-linked dream just that. A dream.
Says Manish Kumar, head (investments), ICICI Prudential Life Insurance Co. Ltd: “Since these have exposure to both equity and debt asset classes, under normal circumstances, the returns can be somewhere between what a debt fund and an equity fund would give.” In the long term, that’s between 6% and 15%.
Has the product started looking less happy? There’s worse to follow.
Costs and more
The guarantees come at a cost making these products some of the most expensive in the market. Also, the guarantee frees them from the cost caps introduced recently.
You need to pay an annual cost for the guarantee, apart from the fund management fee. ICICI Pru’s Pinnacle offers the highest NAV in the first seven years of the policy and charges 0.10% above the fund management charge of 1.35%. Result? Your returns are about 3 percentage points lower—a 15% return will mean a post-cost return of 12%.
These plans also look like investment plans masquerading as insurance plans. The sum assured is capped at five times the premiums (on a premium of Rs1 lakh, you will get a maximum sum assured of Rs5 lakh). Also, most of these are available for a term of up to 10 years. An insurance cover is necessary for most people (other than Shah Rukh Khan and Sachin Tendulkar, who do need insurance) till they retire. So a 10-year policy with just a Rs5 lakh cover looks very much like an investment product under the garb of an insurance policy.
Worse, this guarantee is available to you only on maturity, usually 10 years. If you die during the term, your nominees will get the prevailing value of the fund—the guarantee on NAV works only if you live till the end of the policy.
Should you buy?
Guaranteed products work for investors who do not want a risk to their principal amount, but would like a small upside of equity. If you are looking for a Sensex-linked return kicker with zero risk, please get real. Such products do not exist.
Says Manik Nangia, corporate vice-president and head (product management), Max New York Life Insurance Co. Ltd: “It is possible that the implications of such structures are not well understood. We believe this can create unreasonable expectations. For instance, the allocation to debt can increase substantially when the market falls, while the consumer may have bought on the premise of participating in equity. Besides, there is criticism that this technique necessitates selling equity holdings when the market falls and that is opposite to the principle of value investing for long-term returns.”
Says Veer Sardesai, a Pune-based financial planner: “There is lack of transparency on asset allocation and the insurer doesn’t guarantee that he would stay invested entirely in the stock market during the term. So, we don’t know what high is guaranteed.”
If you are a risk-averse equity investor and can lock in money for 10 years, look at index funds to ride the Sensex and Nifty.