It does not mean that Highest NAV means the NAV when the market was at top in those 7 years.
This is not surprising as the JFM has started and the last date for this financial year (March 31, 2010) comes closer, and people get ready to make tax-saving investments. Also, with last year's stock market crash still fresh in the minds of investors, any sort of guarantee on investment makes for a good marketing proposition.
So here is a lowdown on what these plans are all about and why it makes sense for you to avoid them !
What is a guaranteed NAV plan?
It is essentially a 10-year insurance plan which guarantees the highest NAV for a period of the first seven years of the plan. 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.
How does the guarantee work?
Let us say you invest in a guaranteed investment plan now at a price of Rs 10 per unit. Five years down the line, the NAV is Rs 30, after that the NAV starts to fall and at the time of maturity 10 years on, the NAV is at Rs 15. These plans guarantee the highest NAV achieved during the period of the first seven years of the policy. So, in this case, you will get paid Rs 30 per unit at maturity even though the NAV of a single unit at that point of time is quoting at Rs. 15.
In a more optimistic scenario, if the NAV at maturity is Rs 45, you will be paid Rs 45 per unit. Essentially, the insurance company will pay you the highest of the following three things -- the highest NAV achieved during the first seven years of the policy,the NAV at maturity and Rs 10 per unit. So far so good.
What does the plan invest in?
These plans have a flexibility of investing up to 100% in equity as well as debt. But there is no binding to invest any fixed percentage into equity. The fund manager has complete rights to allocate the corpus according to him. Insurance companies which have launched such plans are of the view that they will decide on the allocation between debt and equity depending on the state of the market. So, if equity markets fall, investments will be moved from equity to debt and vice versa. Any serious market observer will tell you, guaranteeing investments being made into the stock market is not the best way to operate. If such funds plan to invest 100% in equity, how can they guarantee the highest???
NAV, given the fact that the highest NAV will be obvious only in retrospect?
Let us say an insurance company is able to raise Rs 1,000 crore for such a plan by selling units at Rs 10 per unit. Now, during the course of operation, the NAV hits Rs 30, five years down the line. This means the Rs 1,000 crore collected initially is now worth Rs 3,000 crore. As assumed above, Rs 30 is the highest NAV achieved.
At the time of maturity, one unit is worth Rs 15, and the total investments are hence worth Rs 1,500 crore. But as per the guarantee given, the investors need to be compensated the rate of Rs 30 NAV, and hence Rs 3,000 crore is needed. Rs 1,500 crore can be raised by selling the investments at the time of maturity.
This still leaves Rs 1,500 crore (Rs 3,000 crore guarantee - Rs 1,500 crore value of present investments) to be got. So the question is, where is the Rs 1,500 crore going to come from?
Will the insurance company will compensate the investors from its own pockets. But Rs 1,500 crore is a lot of money.
What are such plans betting on?
To an extent, the above example was a rather extreme one -- no company would be willing to take on such huge losses. From the look of it, these companies will have a higher exposure to equity initially and will gradually move the investments into debt as the date of maturity nears. So towards maturity, these funds are likely to have significantly more investments in debt than in equity. Also, the funds are likely to keep booking equity gains and moving them into debt over the period of the plan. This, in a way, will ensure that the equity gains are cashed in, the NAV does not go to very high levels, and the loss on account of the guarantee, if any, is minimal.
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.
These plans use strategies like Dynamic Hedging and CPPI (Constant proportion portfolio insurance), which are advanced strategies used in Derivatives world. Some basic explaination of the whole process :
Supposing a policy starts today and is guaranteed to give highest NAV in next 7 yrs and we can control how money moves to debt and equity, its pretty simple.In the beginning, let’s assume a NAV of Rs 10, and the Asset allocation is 100% in equity and 0% in debt . Now suppose, the market moves up and NAV goes upto Rs 15 by the end of the first year, at this point, try to understand what Insurance company has to provide – they have to make sure, that they provide at least Rs 15 as the return after 6 yrs . Now in order to achieve this, all they have to do is keep X amount in debt instruments which will mature in next 6 years and provide Rs 15 at the end of 6 yrs, so assuming the debt return at 7%, they need to put around Rs 10 in Bonds , so that the maturity of the bond is Rs 15 at the end of 6 yrs .
= > 10 * (1.07)^6
= > 15.007
They can now invest the rest Rs 5 in Equity as Rs 10 is allocated to Debt . So, now they’ve made sure that whatever happens to the market, they get Rs 15 for sure at the end of 6 yrs. Now, there are two possibilities,
Case 1 : Market Goes down : If market goes down, the NAV will go down correspondingly, but as per the strategy, the maturity value will be at least Rs 15.
Case 2 : Market Goes up again : If market goes up at this point and the NAV rises above 15, for example say to Rs. 18, now again they will pull out money from Equity and allocate such an amount to debt, that the maturity at the end of total 7 yrs would be Rs 18 and so on…
Note :
• These highest guaranteed schemes do not provide wide range of product categories, such as equity-oriented growth funds, balance funds and debt funds.
• Guarantee on highest NAV is available only if you survive the term. If you die during the term, your nominees will get the prevailing value of the fund. This is inferior to even a regular debt product because of the high cost structure involved.
Observation : Here Debt option will keep on increasing and at no point, the money can be shifted back to Equity for future upside. This is the major drawback of Highest NAV Guaranteed Plans or Schemes.
How Investors get Confused :
You have to read in between the lines; Investors need to understand that these schemes guarantee the “Highest NAV”, READ AGAIN! , it’s Highest NAV and not “Highest Returns” . Normal Investors don’t give much thought before buying these products and normally assume that the returns will be linked to the Equity Markets.
Actual Returns from Highest NAV Guarantee Plans :
The long-term equity returns, are normally in the range of 12-15% while, debt returns turn out to be 6-7%. So, considering the fact, that these products will shift most of their money to debt, by the end of the tenure , we can expect the returns to be in range of 9-10%. We do get some equity upside in these products, but that will be limited. After a point, this product will turn into a debt oriented fund with a major portion in debt. Also if you factor in costs, like premium allocation charges , fund management charges and other yearly charges, the returns will not be what you actually expect.
You will be amazed to know, that the returns expected from these schemes, may be lower than the returns offered by equity-oriented ULIPs. The reason being, that the basic objective of protecting the previous high NAV of the fund, may constrain the fund manager’s ability to take risks while allocating funds. So if the market has fallen down, the fund manager can’t take the risk of shifting the money from Debt to Equity to gain from the potential upsides in future, because they have to provide the “Guarantee.”
Current Products in Market with Highest NAV Guarantee
■ICICI’s Pinnacle
■Birla Sun Life Platinum Plus-III
■Bajaj Allianz Max Gain
■SBI Life Smart Ulip
■Tata AIG Apex Invest Assure
■LIC Wealth Plus
■Reliance Highest NAV Guarantee Plan.
■AEGON Religare Wealth Protect Plan
Controlling your emotions with these products
Let’s talk about mistakes from the investors point of view. We, as investors, don’t think with inquisitive, susceptive minds. Getting good returns from stock markets is anyways a tough thing in itself. So when these companies come up with plans like these, which say “highest NAV in 7 yrs”, we have to ask, “How is this possible?” . Dont say it’s not possible at all, just ask how? How do they achieve it? Stop seeing dreams of getting high returns without looking at the risk involved, and try to find out – what is the strategy they’re using , Is there something in between the lines ?
We all want to get great returns, but we have to shed this belief that, companies come up with plans specially for us. All the companies out there exist to earn money, and their motive behind every product is to make money, & generate profits for their companies, so that they keep their shareholders happy. So next time a product like this comes up , you have to control your emotions before getting in and first investigate. The worst part of this whole business, (of guaranteed highest NAV products) is the timing and how it gives naive investors, high illusions about the product. Products like these, take major advantage of psychology of the ordinary saver. Many Investors in smaller towns have broken their Fixed Deposits and taken some loan to invest in products like these, especially SBI Life Smart Ulip and LIC Wealth Plus because of the trust factor with LIC and SBI .
How Highest NAV Guarantee Policy Works ?Reasons to stay away :
The first and foremost is that equity markets and guarantees are a very risky idea, as explained above. Do you Know that, The Securities & Exchange Board of India (SEBI) , the stock market and mutual fund regulator, does not allow mutual funds to guarantee returns. Therefore Mutual funds can not provide guaranteed products which are related to stock markets, but IRDA can approve things like these and all these insurance companies come under the ambit of Insurance Regulatory and Development Authority of India (IRDA). So any Insurance Company can come up with a new Plan , link it with market and start providing “Guaranteed products” . You have to understand that “equity markets” and “guarantees” are a very risky idea together , so please stay cautious.
For those who do not remember how risky stock markets and guarantees can be, let us go back a few years in history, and talk about the Unit Trust of India (UTI). UTI had around Rs 17,000 crore invested in its assured return schemes and all these schemes had to be shut down in 2002 when things started to go haywire.
The insurance companies running these plans haven't elaborated on how exactly they plan to manage the guarantee. Investors should also keep in mind that in the world of finance there are no holy cows, as the recent financial crisis clearly shows. Some of the best names in finance have gone bust and investing for 10 years is a long time if the word guarantee comes.
During the course of the plan, you may realize that the returns haven't been up to the mark in comparison to the broader market and may want to exit. Or you may want to exit simply because you need the money. Exiting a Ulip can be a costly affair. This is primarily because most Ulips have upfront charges known as allocation charges which they recover from the investor in order to pay high commissions to insurance agents. Also, the guarantee that comes with these plans is applicable only if the investor stays the entire duration of the plan.
These Insurance companies very well understand investors psychology and their helpless ness at the end of the year because they have to provide investment proofs for Tax exemption as soon as possible . This is not just limited to these products , its true for NFO’s , IPO’s in booming markets , More Sales calls at the end of the year, and other new products.
We have to understand that there is nothing “Innovative” in this product , the fact that 7 companies have come up with the same product proves that its not “innovation” because Innovation is unique . Aegon Religare has gone ahead in this stupidity and introduced their Guaranteed Plan which guaranteed 80% of the Highest NAV , Looks like they think that it makes them look different from others .
The solution :
If you want to invest in the stock market and save on taxes, invest in tax-saving mutual funds. These funds have very low upfront charges and come with a lock in of three years. If three years down the line, you figure out that the performance is not up to the mark, you can simply encash the money and switch to investing in some other mutual fund. If you are looking for an insurance cover as well, buy a term insurance policy. Also, if you are the kind who is looking for guaranteed return, invest in the public provident fund, national savings certificate and tax-saving fixed deposits. And remember that stock markets and guarantees are an extremely risky proposition and don't go together.
So use simple logic,
Invest in the Term Insurance + Mediclaim plan(For Insurance purpose).
Dont invest in insurance just to save taxes, there are many other sources to save taxes. Remember,taxes are the part of your profits.
If you are optimistic smart investor with a moderate risk tolerance and looking for equity returns, invest in direct equity at the recommended levels with a proper guidance bearing a downside of 15% (stop loss).Consider that you invest in Nifty at the level of 5000, your raw stop will be somewhere around 4250 mark.It does not mean that the 5000 would be comfortable level for Nifty to enter long.It may be 4700 or may be above 5300.
Why 15% ?? Reason is, that 15% is the amount which you usually pay under the name of “Allocation charges” in insurance scheme.
Another option is to invest into the Equity (Mutual) Fund and whenever your advisor sees a downside more than 1% over the Nifty or Sensex, redeem all the units and reinvest at the lower NAV. For example, if NAV will be 25 and the advisor expecting the market to fall more than 1% then redeem all the units and reinvest at < 24.75 (1% because the exit load is 1% and no entry load again).
And if you are looking for guaranteed returns, invest in any good debt fund or bonds.
We want to tell you here is not to invest blindly on illusions but think wisely and go for the elusions whenever and wherever its necessary.
For any Details, Contact :
Email : info@integrity.org.in
Call : +91 99750 60000
For abroad clients : +91 9371031008
Disclaimer :
This document has been published in the best interest of our clients.It does not mean that we are recommending not to invest in the mentioned schemes.We have no arguments or debates with any fund houses or insurance companies about their strategies or their commitments.Discalimer:This document has been prepared by the Research Division of Integrity Financial Consultants Pvt. Ltd.,Pune, India and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of iNTEGRITY. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security or any investment scheme under the title of Insurance or Mutual Fund. The information contained in this report has been obtained from sources that are considered to be reliable. However, iNTEGRITY has not independently verified the accuracy or completeness of the same. Neither iNTEGRITY nor any of its affiliates, its directors or its employees accept any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. The suitability or otherwise of any investments will depend upon the recipient's particular circumstances and, in case of doubt, advice should be sought from an independent expert/advisor. Either iNTEGRITY and or its affiliates and or its directors and or its employees and or its representatives and or its associates and or its clients and or their relatives will not be held liable or responsible for any losses or liabilities for any type of issue.No claims will be entertained hereon.The readers or followers of this document are advised to make their own strategies about their investments and or financial planning and or any similar action(s).
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