``No matter how skillful you are, you can`t invent a product advantage that doesn`t exist. And if you do, and it`s just a gimmick, it`s going to fall apart anyway`` - William Bernbach, advertising guru.
Recently, there have been several advertisements of products which guarantee highest value of NAV to investors. Such declarations appear as a relief to the layman who neither understands the intricacies of the stock market nor has the time to `Buy Low and Sell High`. The concept of protecting downside amidst market volatility is indeed quite interesting. However, the devil lies in the detail. Some of the important aspects of any investment product are the expected returns, investment horizon, expenses and of course, your risk profile. Let us see how most of these plans work -
Recently, there have been several advertisements of products which guarantee highest value of NAV to investors. Such declarations appear as a relief to the layman who neither understands the intricacies of the stock market nor has the time to `Buy Low and Sell High`. The concept of protecting downside amidst market volatility is indeed quite interesting. However, the devil lies in the detail. Some of the important aspects of any investment product are the expected returns, investment horizon, expenses and of course, your risk profile. Let us see how most of these plans work -
Timing the Returns
Although, the stock markets in India have been delivering superb returns since 2004, the massive crash of ‐52.45% in 2008 did cause panic amongst the market players and left investors with colossal losses.
No wonder that the retail investors have become wary of the stock market volatility; hence, are increasingly looking at capital protection products. As a result, portfolio insurance strategies of Option Based Portfolio Insurance and Constant Proportion Portfolio Insurance have garnered significance. The 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 the base.
Similarly, the proceeds in Highest NAV guarantee plans would be dynamically invested in equity, fixed income and money markets instruments. However, in Highest NAV Guarantee plan, there is no specific asset allocation that the fund manager has to adhere to unlike a mutual fund or a Unit‐linked Insurance Policy (ULIP). Since Highest NAV Guarantee 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 10 and let`s say the fund has invested into equity. Suppose the stock market rises and NAV goes up to 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 an equity diversified fund or a ULIP.
No Easy Exit
Insurance is ideally a long‐term investment product expected to offer protection to policy holder`s family in the event of an untimely death or disability. A Whole Life policy is typically designed for 15‐25 years. In the absence of the policyholder`s income, the major as well as minor expenses of the family should be compensated through the insurance cover. But the insurance component in Highest NAV Guarantee works merely as a supplementary portion to the entire plan as these plans provide limited cover and 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 three‐five 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 Lunches
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.
Example
Assuming 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 ten years, the maximum permissible sum assured is thirty times the premium which would be just Rs. 300,000 and the annual mortality charge would be approximately Rs. 500. The given table calculates your return considering the Case I (assuming minimum charges applicable), Case II (assuming maximum charges applicable) and Case III (assuming moderate charges).
Please note we have not considered the taxation part in the tabular calculation.
No wonder that the retail investors have become wary of the stock market volatility; hence, are increasingly looking at capital protection products. As a result, portfolio insurance strategies of Option Based Portfolio Insurance and Constant Proportion Portfolio Insurance have garnered significance. The 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 the base.
Similarly, the proceeds in Highest NAV guarantee plans would be dynamically invested in equity, fixed income and money markets instruments. However, in Highest NAV Guarantee plan, there is no specific asset allocation that the fund manager has to adhere to unlike a mutual fund or a Unit‐linked Insurance Policy (ULIP). Since Highest NAV Guarantee 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 10 and let`s say the fund has invested into equity. Suppose the stock market rises and NAV goes up to 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 an equity diversified fund or a ULIP.
No Easy Exit
Insurance is ideally a long‐term investment product expected to offer protection to policy holder`s family in the event of an untimely death or disability. A Whole Life policy is typically designed for 15‐25 years. In the absence of the policyholder`s income, the major as well as minor expenses of the family should be compensated through the insurance cover. But the insurance component in Highest NAV Guarantee works merely as a supplementary portion to the entire plan as these plans provide limited cover and 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 three‐five 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 Lunches
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. Example
Assuming 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 ten years, the maximum permissible sum assured is thirty times the premium which would be just Rs. 300,000 and the annual mortality charge would be approximately Rs. 500. The given table calculates your return considering the Case I (assuming minimum charges applicable), Case II (assuming maximum charges applicable) and Case III (assuming moderate charges).
Please note we have not considered the taxation part in the tabular calculation.
| Condition | Case I | Case II | Case III | Monthly Income Account^ | Monthly Income Plan* |
| Premium | 10,000 | 10,000 | 10,000 | 10,000 | 10,000 |
| The premium allocation charge | 12% | 20% | 15% | 0% | 0% |
| Net amount | 8800 | 8000 | 8500 | 10000 | 10000 |
| Assuming NAV of 10, Units allocated | 880 | 800 | 850 | Not Applicable | 1000 |
| Annual charges priced in the NAV | |||||
| Mortality and Policy Administration Charges | 800 | 1220 | 1000 | 0 | 0 |
| Fund Management and Highest NAV Guarantee Charges | 100 | 185 | 125 | 0 | 200 |
| At maturity | |||||
| Highest NAV | 20 | 12 | 15 | Not Applicable | Not Applicable |
| Fund Value | 17600 | 9600 | 12750 | 15869 | 17447 |
| ^The fund value is calculated at 8% for 6 years | |||||
| *The fund value is calculated using average historical performance of 15 MIPs at 9.72% for 6 years | |||||
We have considered monthly income plans 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 fifteen monthly income plans over five‐year period which comes to annualised 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 and a 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 an POMIA or MIP, even if not than the equity/balanced mutual funds or equity natured ULIPs.
Conclusion
Clearly, these products guarantee Highest NAV but they may not necessarily provide the highest returns, rather they come with high charges. The product may assure you of the highest value of NAV but 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 seven‐eight 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, Monthly Income Plans of mutual funds are a good option. MIPs have an allocation of 10‐15% in equity with the remaining 80‐85% in fixed income securities. Also, the no entry load regime brings down the cost of your mutual fund investments to much lower than these plans. Besides this, to ensure that the family is adequately protected against unexpected and unfortunate events, individuals can go for a whole life term policy which offers a better sum assured value at minimal charges.
Conclusion
Clearly, these products guarantee Highest NAV but they may not necessarily provide the highest returns, rather they come with high charges. The product may assure you of the highest value of NAV but 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 seven‐eight 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, Monthly Income Plans of mutual funds are a good option. MIPs have an allocation of 10‐15% in equity with the remaining 80‐85% in fixed income securities. Also, the no entry load regime brings down the cost of your mutual fund investments to much lower than these plans. Besides this, to ensure that the family is adequately protected against unexpected and unfortunate events, individuals can go for a whole life term policy which offers a better sum assured value at minimal charges.
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