When a corporate house defaults on payment, analysts quickly dish out charts and tables that show the impact on MFs as these products have better disclosures and are more transparent. When such events happened in the past, investors rushed to withdraw money from MFs.
However, there is hardly any analysis on how debt funds of Ulips are affected due to such defaults. Ulip investors, in fact, do not behave like MF investors and redeem in a panic.
“Unlike MFs, debt funds of Ulips are not subject to higher scrutiny by investors. Most insurers are not mandated to disclose their entire portfolio, and most of them don’t do it," said Kaustubh Belapurkar, director, fund research, Morningstar Investment Adviser India.
But this is just one of the many reasons. The different reaction to defaults has a lot to do with what individuals expect from their investments in MFs and Ulips, the way the two products are sold and the regulations governing them.
Both the Insurance Regulatory and Development Authority of India (Irdai) and the Securities and Exchange Board of India (Sebi) have similar norms to deal with debt papers that face default or rating downgrades. MFs as well as insurers need to have a board-approved policy to write down the value of such papers.
When companies rated triple-A (AAA) such as IL&FS and DHFL stopped repaying MFs and insurance companies, the values of their papers were written down to zero over a few days.
But MFs have better tools available to them to manage defaults and downgrades. After a few defaults, Sebi introduced a concept call side-pocketing. It is an accounting method that is used to separate illiquid investments from liquid and quality investment in a debt portfolio. It helps small investors if their scheme witnesses high redemption. Such options are not yet available with Ulips.
MFs also need to stick to their mandates. Sebi had recategorized different funds and defined what securities fund managers can and cannot keep in their portfolios. For debt funds, it has also defined the average portfolio maturity, depending on the category. In short-term funds, for example, the duration of the portfolio must be between one and three years.
In Ulips, however, it is up to the insurers to stick to the fund’s mandate. As interest rates have been falling, some debt funds in the short duration category in Ulips have added 10-year government securities (G-secs) in large proportions (above 50% of the portfolio) pushing up the average portfolio maturity, according to insurers’ portfolio disclosures.
Debt funds from insurers do have some restrictions that the regulator has imposed. Explains chief investment officer with a life insurance company, who didn’t want to be named: “The debt fund portfolio should have a minimum 75% AAA-rated papers or G-Secs (in Ulip debt funds). Irdai has also specified the list of instruments that debt funds can invest in."
Like MFs, in Ulips too, there are restrictions on exposure to a single company (up to 10%) and total exposure to a single corporate group (up to 15%).
Equity dominates Ulips
In the MF industry, the assets under management (AUM) of debt funds are far higher compared to equity funds. It is the reverse in Ulips. “When an individual invests in Ulips, it’s primarily for equity. About one in four investors put their money in debt funds of Ulips," said A.K. Sridhar, director and chief investment officer, IndiaFirst Life Insurance Co. Ltd.
In MFs, there are 16 categories of debt funds, which cater to different needs. Investors can use debt funds to park money for a few days or for several years. “In Ulips, most companies keep two-three debt funds. Ulip investments are for the long term. There’s a lock-in for five years," said Sridhar. So most insurers offer medium- to long-term funds.
Some Ulips have liquid funds to meet investors’ demand for short-term parking of funds. They are usually meant for those who want to proactively manage their investments under Ulips, which allow switching from one fund to another, sometimes for a fee.
Type of investors
Both MFs and Ulips are geared towards generating returns. But that’s where the similarity ends. The major difference is in how investors perceive the two products. MFs have greater disclosure compared to Ulips, whose product constructs are more restrictive. Also, mis-selling in Ulips is higher than in MFs as the former pays higher distributor commissions.
Those who invest in MFs are usually savvier than those who opt for Ulips, according to financial planners. Individuals who invest via Ulips, typically, neither scrutinize funds like they would do with an MF scheme nor check the returns as frequently as the information may not be easily available.
Many are not even aware of the portfolio of the funds they select under Ulips. “They don’t get to see the daily volatility in their funds. They check the returns in the communications they receive from the insurer periodically," said Deepesh Raghaw, founder, PersonalFinancePlan, a Sebi-registered investment adviser.
Understanding a Ulip statement can also be challenging. “It usually comprises of multiple entries that runs into several pages," said Malhar Majumder, a Kolkata-based financial planner and partner, Positive Vibes Consulting and Advisory. It’s only at maturity or at the time of surrender that they look at the returns on the total premiums paid through the term. Mutual fund statements are quite straightforward to understand.
MFs come into the limelight on defaults because investors can immediately act on the developments. They can choose to withdraw and shift to another investment product. Ulip investors have little choice. They need to continue paying premiums for at least five years before they can even think of exiting their investments.