Timing the returns:
Although the stock markets in India have been delivering superb returns since 2004, the massive crash of -52.45% in did cause panic amongst the market players and left investors with colossal losses. No wonder retail investors have become wary of the stock market volatility and are increasingly looking at capital protection products.
That explains the launch of the highest NAV guarantee unit-linked insurance plans (Ulips).
A highest NAV guarantee plan is based on the constant proportion portfolio insurance (CPPI) model. According to this model, the fund would invest in fixed-income type of securities in order to maintain a certain minimum unit value. When the fund value exceeds this floor value, the surplus is placed into stocks. With constant rebalancing of the portfolio, the aim of the fund manager is to not let the unit value fall below a certain base value.
Similarly, the proceeds in highest NAV guarantee plans would be invested in equity, fixed income and money markets instruments. However, in such plans, there is no specific asset allocation that the fund manager has to adhere to, unlike a mutual fund or Ulips Nav. Since such plans are a new product, there is no historical data to evaluate the performance of the said funds.
As the policy guarantees you the highest NAV, a fund manager
May follow a conservative approach and allocate your money into money market and fixed income instruments and ensure that you get the highest NAV without much trouble. At the beginning, the NAV is Rs 10 and let's say the fund has invested into equity. Suppose the stock market rises and NAV goes up to Rs 12. As the fund has already made a gain of 20%, the fund manager has to maintain this NAV at least for next 6-8 years.
Consequently, the fund would be rebalanced into fixed income securities to ensure that the fund maintains the NAV of 12. Thus, even though the fund manager may fluctuate from equity to fixed income or money market, the returns may not be comparable to equity-diversified mutual funds.
No easy exit:
The insurance component in highest NAV guarantee works merely as a supplementary portion to the entire plan as these plans provide limited cover. Also most of them offer guarantee at maturity after a period of 7-10 years. Secondly, the highest NAV guarantee terminates past the grace period when you stop paying your premiums. The exit from the plan or partial withdrawals is possible only after 3-5 years. Also, for partial withdrawals or surrenders which attract an exit charge of 0-20%, this guarantee is not applicable. Thus, these plans do not offer immediate liquidity.
No free lunch:
Now, consider the actual investible part. These plans have five types of charges as shown in the chart. The charges lie in the given range for products of different companies.
The units are calculated after deduction of premium allocation charge. So the balance from premium received goes as an investment into the fund. Apart from initial charges, the mortality, policy administration charges and fund management charges are deducted every year from your fund. There is a fund management fee plus a charge for highest NAV guarantee to assure that you get highest NAV which would be deducted from your fund units. In totality, besides the premium allocation charge, you would end up paying from your fund approximately 2.50% per annum. In the later years, the premium allocation charges may come down but other charges would remain.
Let's assume a person aged 35 pays a premium of Rs 10,000 every year through an intermediary into the plan. Let's say for a policy term of 10 years, the maximum permissible sum assured is thirty times the premium which would be just Rs 3 lakh and the annual mortality charge would be approximately Rs 500. The given table (left) calculates the return considering three scenarios:
Case I (assuming minimum charges applicable)
Case II (assuming maximum charges applicable)
Case III (assuming moderate charges)
We have considered monthly income plans (MIP) of mutual funds as they have lesser allocation, about 15-25% to equity and Post Office - Monthly Income Account (POMIA) in the table.
The POMIA gives an interest at the rate of 8% which is paid monthly as a regular income avenue and is not cumulative in nature. At maturity, the deposit attracts a bonus as well. For simplicity, we have considered increase in value of deposit over six years. Also, we have taken into account the average historical performance of 15 monthly income plans of mutual funds over five-year period, which comes to an annualized 9.72%.
Even though the fund NAV would rise by 50% (as in Case III), the returns at the end of the period would be lower than that in a POMIA or an MIP.
Despite the highest NAV assurance and a 20% increase in NAV (as in Case II), after deducting all charges, you are actually negative on your investment. In fact, your fund value net of all charges should exceed almost 25% in the first year itself to get your capital back from the fund. Only if the fund NAV were to double (as in Case I), would the performance better a POMIA or MIP, but not equity/ balanced mutual funds or equity-natured Ulips.
Clearly, these products guarantee highest NAV, but they may not necessarily provide the highest returns. Rather, they come with high charges. The fund manager is restricted in terms of investment decisions and may not be able to optimize the returns from the fund.
Investors who are risk-averse and have a 7-8 year horizon are better off with postal schemes or bank deposits which have no charges and provide certain fixed returns.
For investors who prefer equity flavor in their investments, MIPs of mutual funds are a good option
Such plans allocate 10-15% to equity and the rest to fixed income securities. Also, the no entry load regime brings down the cost of your mutual fund investments to much lower than highest NAV guarantee plans.
Source : http://www.dnaindia.com/money/report-highest-nav-ulips-are-pure-marketing-gimmick-1367847