Post on 06-Apr-2018
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MUTUAL FUND INDUSTRY PROFILE
The mutual fund industry is a lot like the film star of the finance business.
Though it is perhaps the smallest segment of the industry, it is also the most
glamorous in that it is a young industry where there are changes in the rules
of the game everyday, and there are constant shifts and upheavals.
The mutual fund is structured around a fairly simple concept, the mitigation
of risk through the spreading of investments across multiple entities, which is
achieved by the pooling of a number of small investments into a large bucket.
Yet it has been the subject of perhaps the most elaborate and prolonged
regulatory effort in the history of the country.
A little history:
The mutual fund industry started in India in a small way with the UTI Act
creating what was effectively a small savings division within the RBI. Over a
period of 25 years this grew fairly successfully and gave investors a good
return, and therefore in 1989, as the next logical step, public sector banks
and financial institutions were allowed to float mutual funds and their success
emboldened the government to allow the private sector to foray into this area.
The initial years of the industry also saw the emerging years of the Indian
equity market, when a number of mistakes were made and hence the mutual
fund schemes, which invested in lesser-known stocks and at very high levels,
became loss leaders for retail investors. From those days to today the retail
investor, for whom the mutual fund is actually intended, has not yet returned
to the industry in a big way. But to be fair, the industry too has focused on
brining in the large investor, so that it can create a significant base corpus,
which can make the retail investor feel more secure.
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Some facts for the growth of mutual funds in India
100% growth in the last 6 years.
Number of foreign AMCs is in the queue to enter the Indian markets.
Our saving rate is over 23%, highest in the world. Only channelizing these
savings in mutual funds sector is required.
We have approximately 29 mutual funds which is much less than US having
more than 800. There is a big scope for expansion.
Mutual fund can penetrate rurals like the Indian insurance industry with simple
and limited products.
SEBI allowing the MF's to launch commodity mutual funds.
Emphasis on better corporate governance.
Trying to curb the late trading practices.
Introduction of Financial Planners who can provide need based advice.
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CHARACTERISTICS OF MUTUAL FUNDS
The ownership is in the hands of the investors who have pooled in their funds.
It is managed by a team of investment professionals and other service
providers.
The pool of funds is invested in a portfolio of marketable investments.
The investors share is denominated by units whose value is called as Net
Asset Value (NAV) which changes everyday.
The investment portfolio is created according to the stated investment
objectives of the fund.
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ADVANTAGES OF MUTUAL FUNDS
The advantages of mutual funds are given below: -
Portfolio Diversification
Mutual funds invest in a number of companies. This diversification reduces the
risk because it happens very rarely that all the stocks decline at the same time and in
the same proportion. So this is the main advantage of mutual funds.
Professional Management
Mutual funds provide the services of experienced and skilled professionals,
assisted by investment research team that analysis the performance and prospects
of companies and select the suitable investments to achieve the objectives of the
scheme.
Low Costs
Mutual funds are a relatively less expensive way to invest as compare to directly
investing in a capital markets because of less amount of brokerage and other fees.
Liquidity
This is the main advantage of mutual fund, that is whenever an investor needs
money he can easily get redemption, which is not possible in most of other options of
investment. In open-ended schemes of mutual fund, the investor gets the money
back at net asset value and on the other hand in close-ended schemes the units can
be sold in a stock exchange at a prevailing market price.
Transparency
In mutual fund, investors get full information of the value of their investment,
the proportion of money invested in each class of assets and the fund managers
investment strategy
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Flexibility
Flexibility is also the main advantage of mutual fund. Through this investors can
systematically invest or withdraw funds according to their needs and convenience
like regular investment plans, regular withdrawal plans, dividend reinvestment plans
etc.
Convenient Administration
Investing in a mutual fund reduces paperwork and helps investors to avoid many
problems like bad deliveries, delayed payments and follow up with brokers and
companies. Mutual funds save time and makeinvesting easy.
Affordability
Investors individually may lack sufficient funds to invest in high-grade stocks. A
mutual fund because of its large corpus allows even a small investor to take the
benefit of its investment strategy.
Well Regulated
All mutual funds are registered with SEBI and they function with in the provisions
of strict regulations designed to protect the interest of investors. The operations of
mutual funds are regularly monitored by SEBI.
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DISADVANTAGES OF MUTUAL FUNDS
Mutual funds have the following drawbacks:
No Guarantees
No investment is risk free. If the entire stock market declines in value, the value
of mutual fund shares will go down as well, no matter how balanced the portfolio.
Investors encounter fewer risks when they invest in mutual funds than when they buy
and sell stocks on their own. However, anyone who invests through mutual fund runs
the risk of losing the money.
Fees and Commissions
All funds charge administrative fees to cover their day to day expenses. Some
funds also charge sales commissions or loads to compensate brokers, financial
consultants, or financial planners. Even if you dont use a broker or other financial
advisor, you will pay a sales commission if you buy shares in a Load Fund.
Taxes
During a typical year, most actively managed mutual funds sell anywhere from
20 to 70 percent of the securities in their portfolios. If your fund makes a profit on its
sales, you will pay taxes on the income you receive, even you reinvest the money
you made.
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Management Risk
When you invest in mutual fund, you depend on fund manager to make the right
decisions regarding the funds portfolio. If the manager does not perform as well as
you had hoped, you might not make as much money on your investment as you
expected. Of course, if you invest in index funds, you forego management risk
because these funds do not employ managers.
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STRUCTURE OF MUTUAL FUND
There are many entities involved and the diagram below illustrates the structure of
mutual funds: -
Structure of Mutual Funds
SEBI
The regulation of mutual funds operating in India falls under the preview of
authority of the Securities and Exchange Board of India (SEBI). Any person
proposing to set up a mutual fund in India is required under the SEBI (Mutual Funds)
Regulations, 1996 to be registered with the SEBI.
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Sponsor
The sponsor should contribute at least 40% to the net worth of the AMC.
However, if any person holds 40% or more of the net worth of an AMC shall be
deemed to be a sponsor and will be required to fulfill the eligibility criteria in the
Mutual Fund Regulations. The sponsor or any of its directors or the principal officer
employed by the mutual fund should not be guilty of fraud or guilty of any economic
offence.
Trustees
The mutual fund is required to have an independent Board of Trustees, i.e. twothird of the trustees should be independent persons who are not associated with the
sponsors in any manner. An AMC or any of its officers or employees are not eligible
to act as a trustee of any mutual fund. The trustees are responsible for - inter alia
ensuring that the AMC has all its systems in place, all key personnel, auditors,
registrar etc. have been appointed prior to the launch of any scheme.
Asset Management Company
The sponsors or the trustees are required to appoint an AMC to manage the
assets of the mutual fund. Under the mutual fund regulations, the applicant must
satisfy certain eligibility criteria in order to qualify to register with SEBI as an AMC.
1. The sponsor must have at least 40% stake in the AMC.
2. The chairman of the AMC is not a trustee of any mutual fund.
3. The AMC should have and must at all times maintain a minimum net worth of
Cr. 100 million.
4. The director of the AMC should be a person having adequate professional
experience.
5. The board of directors of such AMC has at least 50% directors who are not
associate of or associated in any manner with the sponsor or any of its
subsidiaries or the trustees.
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The Transfer Agents
The transfer agent is contracted by the AMC and is responsible for maintaining
the register of investors / unit holders and every day settlements of purchases and
redemption of units. The role of a transfer agent is to collect data from distributors
relating to daily purchases and redemption of units.
Custodian
The mutual fund is required, under the Mutual Fund Regulations, to appoint a
custodian to carry out the custodial services for the schemes of the fund. Only
institutions with substantial organizational strength, service capability in terms ofcomputerization and other infrastructure facilities are approved to act as custodians.
The custodian must be totally delinked from the AMC and must be registered with
SEBI.
Unit Holders
They are the parties to whom the mutual fund is sold. They are ultimate
beneficiary of the income earned by the mutual funds.
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TYPES OF MUTUAL FUND SCHEMES
In India, there are many companies, both public and private that are engaged in the
trading of mutual funds. Wide varieties of Mutual Fund Schemes exist to cater to the
needs such as financial position, risk tolerance and return expectations etc.
Investment can be made either in the debt Securities or equity .The table below
gives an overview into the existing types of schemes in the Industry.
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Generally two options are available for every scheme regarding dividend payout and
growth option. By opting for growth option an investor can have the benefit of long-
term growth in the stock market on the other side by opting for the dividend option an
investor can maintain his liquidity by receiving dividend time to time. Some time
people refer dividend option as dividend fund and growth fund. Generally decisions
regarding declaration of the dividend depend upon the performance of stock market
and performance of the fund.
OPTION REGARDING DIVIDEND
Dividend Growth
ReinvestedPayout
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Unit Linked Insurance Plan - ULIP
ULIP is the Product Innovation of the conventional Insurance product. With
the decline in the popularity of traditional Insurance products & changing
Investor needs in terms of life protection, periodicity, returns & liquidity, it
was need of the hour to have an Instrument that offers all these features
bundled into one.
A Unit Link Insurance Policy (ULIP) is one in which the customer is provided with a
life insurance cover and the premium paid is invested in either debt or equity
products or a combination of the two. In other words, it enables the buyer to secure
some protection for his family in the event of his untimely death and at the same time
provides him an opportunity to earn a return on his premium paid. In the event of the
insured person's untimely death, his nominees would normally receive an amount
that is the higher of the sum assured or the value of the units (investments).
To put it simply, ULIP attempts to fulfill investment needs of an investor with
protection/insurance needs of an insurance seeker. It saves the investor/insurance-
seeker the hassles of managing and tracking a portfolio or products. More
importantly ULIPs offer investors the opportunity to select a product which matches
their risk profile.
Unit Linked Insurance Plans came into play in the 1960s and became very popular in
Western Europe and Americas. In India The first unit linked Insurance Plan ,
popularly known as ULIP Unit Linked Insurance Plan in India was brought out by
Unit Trust Of India in the year 1971 by entering into a group insurance arrangement
with LIC o provide for life cover to the investors , while UTI , as a mutual was taking
care of investing the unit holders money in the capital market and giving them a fair
return .
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TYPES OF ULIP
There are various unit linked insurance plans available in the market. However, the
key ones are pension, children, group and capital guarantee plans.
The pension plans come with two variations with and without life cover and are
meant for people who want to generate returns for their sunset years.
The children plans, on the other hand, are aimed at taking care of their educational
and other needs..
Apart from unit-linked plans for individuals, group unit linked plans are also available
in the market. The Group linked plans are basically designed for employers who
want to offer certain benefits for their employees such as gratuity, superannuation
and leave encashment.
The other important category of ULIPs is capital guarantee plans. The plan promises
the policyholder that at least the premium paid will be returned at maturity. But the
guaranteed amount is payable only when the policy's maturity value is below the
total premium paid by the individual till maturity. However, the guarantee is not
provided on the actual premium paid but only on that portion of the premium that is
net of expenses (mortality, sales and marketing, administration).
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How ULIPs work
ULIPs work on the lines of mutual funds. The premium paid by the client (less any
charge) is used to buy units in various funds (aggressive, balanced or conservative)floated by the insurance companies. Units are bought according to the plan chosen
by the policyholder. On every additional premium, more units are allotted to his fund.
The policyholder can also switch among the funds as and when he desires. While
some companies allow any number of free switches to the policyholder, some restrict
the number to just three or four. If the number is exceeded, a certain charge is
levied.
Individuals can also make additional investments (besides premium) from time to
time to increase the savings component in their plan. This facility is termed "top-up".
The money parked in a ULIP plan is returned either on the insured's death or in the
event of maturity of the policy. In case of the insured person's untimely death, the
amount that the beneficiary is paid is the higher of the sum assured (insurance
cover) or the value of the units (investments). However, some schemes pay the sum
assured plus the prevailing value of the investments.
ULIP - KEY FEATURES
Premiums paid can be single, regular or variable. The payment period too can
be regular or variable. The risk cover can be increased or decreased.
As in all insurance policies, the risk charge (mortality rate) varies with age.
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The maturity benefit is not typically a fixed amount and the maturity period can
be advanced or extended.
Investments can be made in gilt funds, balanced funds, money market funds,growth funds or bonds.
The policyholder can switch between schemes, for instance, balanced to debt
or gilt to equity, etc.
The maturity benefit is the net asset value of the units.
The costs in ULIP are higher because there is a life insurance component in it
as well, in addition to the investment component.
Insurance companies have the discretion to decide on their investment
portfolios.
Being transparent the policyholder gets the entire episode on the performance
of his fund.
ULIP products are exempted from tax and they provide life insurance.
Provides capital appreciation.
Investor gets an option to choose among debt, balanced and equity funds.
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USP of ULIPS
Insurance cover plus savings
ULIPs serve the purpose of providing life insurance combined with savings at
market-linked returns. To that extent, ULIPS can be termed as a two-in-one plan in
terms of giving an individual the twin benefits of life insurance plus savings.
Multiple investment options
ULIPS offer a lot more variety than traditional life insurance plans. So there are
multiple options at the individuals disposal. ULIPS generally come in three broad
variants:
Aggressive ULIPS (which can typically invest 80%-100% in equities, balance
in debt)
Balanced ULIPS (can typically invest around 40%-60% in equities)
Conservative ULIPS (can typically invest upto 20% in equities)
Although this is how the ULIP options are generally designed, the exact debt/equity
allocations may vary across insurance companies. Individuals can opt for a variantbased on their risk profile.
Flexibility
The flexibility with which individuals can switch between the ULIP variants to
capitalise on investment opportunities across the equity and debt markets is what
distinguishes it from other instruments. Some insurance companies allow a certain
number of free switches. Switching also helps individuals on another front. They
can shift from an Aggressive to a Balanced or a Conservative ULIP as they approach
retirement. This is a reflection of the change in their risk appetite as they grow older.
Works like an SIP
Rupee cost-averaging is another important benefit associated with ULIPS. With an
SIP, individuals invest their monies regularly over time intervals of a month/quarter
and dont have to worry about timing the stock markets.
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HURDLES OF ULIP
NO STANDARDIZATION
All the costs are levied in ways that do not lend to standardisation. If one company
calculates administration cost by a formula, another levies a flat rate. If one company
allows a range of the sum assured (SA), another allows only a multiple of the
premium. There was also the problem of a varying cost structure with age
LACK OF FLEXIBILITY IN LIFE COVER
ULIP is known to be more flexible in nature than the traditional plans and, on most
counts, they are. However, some insurance companies do not allow the individual to
fix the life cover that he needs. These rely on a multiplier that is fixed by the insurer
OVERSTATING THE YIELD
Insurance companies work on illustrations. They are allowed to show you how much
your annual premium will be worth if it grew at 10 per cent per annum. But there are
costs, so each company also gives a post-cost return at the 10 per cent illustration,
calling it the yield. some companies were not including the mortality cost while
calculating the yield. This amounts to overstating the yield.
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INTERNALLY MADE SALES ILLUSTRATION
During the process of collecting information, it was found that the sales benefit
illustration shown was not conforming to the Insurance Regulatory and Development
Authority (Irda) format. in many locations30 per cent return illustrations are still
rampant
NOT ALL SHOW THE BENCHMARK RETURN
To talk about returns without pegging them to a benchmark is misleading the
customer. Though most companies use Sensex, BSE 100 or the Nifty as the
benchmark, or the measuring rod of performance, some companies are not using
any benchmark at all.
EARLY EXIT OPTIONS
The Ulip product works over the long term. The earlier the exit, the worse off is the
investor since he ends up redeeming a high-front-load product and is then
encouraged to move into another higher cost product at that stage. An early exit also
takes away the benefit of compounding from insured.
CREEPING COSTS
Since the investors are now more aware than before and have begun to ask for
costs, some companies have found a way to answer that without disclosing too
much. People are now asking how much of the premium will go to work. There are
plans that are able to say 92 per cent will be invested, that is, will have a front load of just 8 per cent. What they do not say is the much higher policy administration cost
that is tucked away inside (adjusted from the fund value).
While most insurance companies charge an annual fee of about Rs 600 as
administration costs, that stay fixed over time, there are plans that charge this
amount, but it grows by as much as 5 per cent a year over time. There are others
that charge a multiple of this amount and that too grows
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COMPARISON BETWEEN ULIPS AND MUTUAL FUNDS:
Unit Linked Insurance Policies (ULIPs) as an investment avenue are closest to
mutual funds in terms of their structure and functioning. As is the case with mutualfunds, investors in ULIPs are allotted units by the insurance company and a net
asset value (NAV) is declared for the same on a daily basis.
Similarly ULIP investors have the option of investing across various schemes similar
to the ones found in the mutual funds domain, i.e. diversified equity funds, balanced
funds and debt funds to name a few. Generally speaking, ULIPs can be termed as
mutual fund schemes with an insurance component.
However it should not be construed that barring the insurance element there is
nothing differentiating mutual funds from ULIPs.
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Points of difference between the two:
1. Mode of investment/ investment amounts
Mutual fund investors have the option of either making lump sum investments or
investing using the systematic investment plan (SIP) route which entails
commitments over longer time horizons. The minimum investment amounts are laid
out by the fund house.
ULIP investors also have the choice of investing in a lump sum (single premium) or
using the conventional route, i.e. making premium payments on an annual, half-
yearly, quarterly or monthly basis. In ULIPs, determining the premium paid is often
the starting point for the investment activity.
This is in stark contrast to conventional insurance plans where the sum assured is
the starting point and premiums to be paid are determined thereafter.
ULIP investors also have the flexibility to alter the premium amounts during the
policy's tenure. For example an individual with access to surplus funds can enhance
the contribution thereby ensuring that his surplus funds are gainfully invested;
conversely an individual faced with a liquidity crunch has the option of paying a loweramount (the difference being adjusted in the accumulated value of his ULIP). The
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freedom to modify premium payments at one's convenience clearly gives ULIP
investors an edge over their mutual fund counterparts.
2. Expenses
In mutual fund investments, expenses charged for various activities like fund
management, sales and marketing, administration among others are subject to pre-
determined upper limits as prescribed by the Securities and Exchange Board of
India.
For example equity-oriented funds can charge their investors a maximum of 2.5%
per annum on a recurring basis for all their expenses; any expense above the
prescribed limit is borne by the fund house and not the investors.
Similarly funds also charge their investors entry and exit loads (in most cases, either
is applicable). Entry loads are charged at the timing of making an investment while
the exit load is charged at the time of sale.
Insurance companies have a free hand in levying expenses on their ULIP products
with no upper limits being prescribed by the regulator, i.e. the Insurance Regulatory
and Development Authority. This explains the complex and at times 'unwieldy'
expense structures on ULIP offerings. The only restraint placed is that insurers are
required to notify the regulator of all the expenses that will be charged on their ULIP
offerings.
Expenses can have far-reaching consequences on investors since higher expenses
translate into lower amounts being invested and a smaller corpus being
accumulated. ULIP-related expenses have been dealt with in detail in the article
"Understanding ULIP expenses".
3. Portfolio disclosure
Mutual fund houses are required to statutorily declare their portfolios on a quarterlybasis, albeit most fund houses do so on a monthly basis. Investors get the
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opportunity to see where their monies are being invested and how they have been
managed by studying the portfolio.
There is lack of consensus on whether ULIPs are required to disclose their portfolios.
During our interactions with leading insurers we came across divergent views on this
issue.
While one school of thought believes that disclosing portfolios on a quarterly basis is
mandatory, the other believes that there is no legal obligation to do so and that
insurers are required to disclose their portfolios only on demand.
Some insurance companies do declare their portfolios on a monthly/quarterly basis.
However the lack of transparency in ULIP investments could be a cause for concern
considering that the amount invested in insurance policies is essentially meant to
provide for contingencies and for long-term needs like retirement; regular portfolio
disclosures on the other hand can enable investors to make timely investment
decisions.
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4. Flexibility in altering the asset allocation
As was stated earlier, offerings in both the mutual funds segment and ULIPs
segment are largely comparable. For example plans that invest their entire corpus in
equities (diversified equity funds), a 60:40 allotment in equity and debt instruments
(balanced funds) and those investing only in debt instruments (debt funds) can be
found in both ULIPs and mutual funds.
If a mutual fund investor in a diversified equity fund wishes to shift his corpus into a
debt from the same fund house, he could have to bear an exit load and/or entry load.
On the other hand most insurance companies permit their ULIP inventors to shift
investments across various plans/asset classes either at a nominal or no cost
(usually, a couple of switches are allowed free of charge every year and a cost has
to be borne for additional switches).
Effectively the ULIP investor is given the option to invest across asset classes as per
his convenience in a cost-effective manner.
This can prove to be very useful for investors, for example in a bull market when the
ULIP investor's equity component has appreciated, he can book profits by simply
transferring the requisite amount to a debt-oriented plan.
5. Tax benefits
ULIP investments qualify for deductions under Section 80C of the Income Tax Act.
This holds good, irrespective of the nature of the plan chosen by the investor. On the
other hand in the mutual funds domain, only investments in tax-saving funds (also
referred to as equity-linked savings schemes) are eligible for Section 80C benefits.
Maturity proceeds from ULIPs are tax free. In case of equity-oriented funds (for
example diversified equity funds, balanced funds), if the investments are held for a
period over 12 months, the gains are tax free; conversely investments sold within a12-month period attract short-term capital gains tax @ 10%.
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Similarly, debt-oriented funds attract a long-term capital gains tax @ 10%, while a
short-term capital gain is taxed at the investor's marginal tax rate.
Despite the seemingly similar structures evidently both mutual funds and ULIPs have
their unique set of advantages to offer. As always, it is vital for investors to be aware
of the nuances in both offerings and make informed decisions.
ULIPS VERSUS MUTUAL FUNDS
Unit Links Insurance Plan (ULIP) andMutual Fund(MF) are the two mostpreferred
options for a part time investor to invest into equity. But how do wedecide which one
should we go for. Though it is very easy to decide, peopletend to confuse
themselves most of the time. This article talks about somepoints that you need to
consider while deciding which option we want to take.Mutual Fund is pure
investments. ULIP are combination of Insurance andInvestment.
Now let us compare ULIP and MF based on certain well known facts:
1) Insurance
ULIPs provide you with insurance cover.MFs dont provide you with insurance
cover. A point in favor of ULIPs. But let me tell you that you dont get thisinsurance
cover for free. Mortality charges (i.e. the price you pay for theinsurance cover) get
deducted from your investment.
2) Entry Load
ULIPs generally come with a huge entry load. For different schemes, this canvary
between 5 to 40% of the first years premium.MFs do not have any entryload. Here
MFs have a huge advantage. If we consider a conservative marketreturn of about
10-15% you may get a zero percent return in the first year incase of ULIPs.
3) Maturity
ULIPs generally come with a maturity of 5 to 20 years. That what ever moneyyou put
in, most of it will be locked-in till the maturity.Taxes saving MF (Popularly called as
Equity Linked Saving Scheme or ELSS)come with a lock-in period of 3 years. Other
MFs dont have a lock-in period.Again MFs have advantage over ULIPs. ULIPs do
allow you to take money outprematurely but they also put penalties on you for doing
that.
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4) Compulsion of Investing
ULIPs would generally make you pay at least first three premiums.MFs dont have
any compulsion on future investments.If you have invested in a MF this year, and in
the next year you dont haveenough income or money to do investments you can
decide not to make anyinvestments. Also if you notice that the MF that you invested
in is not givinggood returns as compared to some other Funds scheme, you can
decide toinvest in some other MF.
5) Tax Saving
Both the ELSS and ULIP come under 80C and can save you tax. Returns in theboth
form of investments are tax free.
6) Market exposure
ULIPs give you both moderate and aggressive exposure to equity marketDebt and
Liquid MF let invest with low risk, but dont give you tax benefit.ULIPs need not be
aggressive in equity exposure. That is ULIPs need not keepmore that 60% of their
funds in equity market. ULIPS also allow to changeyour equity market exposure.
Thus it can help you time the market and stillgive you tax savings. If a MF has a less
than 60% exposure to equity marketthe returns from it are not tax free. Thus you
dont get to take a conservativestand on returns.
7) Flexibility of time of redemption
ULIP will get redeemed on maturing. Premature redemption is allowed withsome
penalty. In MF premature redemption is not allowed. For a open endedscheme one
can redeem the MF anytime after maturiryThis is mainly useful if the market is down
at the maturity time of the investment. In case of ELSSyou can wait till the market
comes up again and then redeem them. ULIPscheme wont allow you to wait.
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Thus, both ULIPs and mutual funds target the same customers. If risk cover is
your primary objective, pure insurance plans are less expensive.
When we choose a mutual fund, we look for an established track record of three to
five years of consistent returns across various market cycles to judge a fund's
performance.
It is early days for insurance companies on this score; investing substantially in
linked plans might not be advisable at this juncture.
ULIP's usually have following charges built into it :
a) Up-front Charges
b) Mortality Charges ( Charges for providing the risk cover for life)
c) Administrative Charges
d) Fund Management Charges
Mutual Fund's have the following charges :
a) Up-front charges ( Marketing, Advertising, distributors fee etc.)
b) Fund Management Charges ( expenses for managing your fund)
A few aspects of investing in ULIPs versus mutual funds.
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Liquidity
ULIPs score low on liquidity. According to guidelines of the Insurance Regulatory
and Development Authority (IRDA), ULIPs have a minimum term of five years and a
minimum lockin of three years. You can make partial withdrawals after three years.
The surrender value of a ULIP is low in the initial years, since the insurer deducts a
large part of your premium as marketing and distribution costs. ULIPs are essentially
long-term products that make sense only if your time horizon is 10 to 20 years.
Mutual fund investments, on the other hand, can be redeemed at any time, barring
ELSS (equity-linked savings schemes). Exit loads, if applicable , are generally for six
months to a year in equity funds. So mutual funds score substantially higher on
liquidity.
Tax efficiency
ULIPs are often pitched as tax-efficient , because your investment is eligible for
exemption under Section 80C of the Income Tax Act (subject to a limit of Rs 1 lakh).
But investments in ELSS schemes of mutual funds are also eligible for exemption
under the same section .Besides the premium, the maturity amount in ULIPs is also
tax-free , irrespective of whether the investment was in a balanced or debt plan. So
they do have an edge on mutual funds, as debt funds are taxed at 10% without
indexation benefits, and 20% with indexation benefits. The point, though, is that if
you invest in a debt plan through a ULIP, despite its tax-efficiency your post-tax
returns will be low, because of high front-end costs. Debt mutual funds dont charge
such costs.
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Expenses
Insurance agents get high commissions for ULIPs, and they get them in the initial
years, not staggered over the term. So the insurer recovers most charges from you
in the initial years, as it risks a loss if the policy lapses. Typically , insurers levy
enormous selling charges, averaging more than 20% of the first years premium, and
dropping to 10% and 7.5% in subsequent years. (And this is after investors balked
when charges were as high as 65%!) Compare this with mutual funds fees of 2.25%
on entry, uniform for all schemes. Different ULIPs have varying charges, often not
made clear to investors.
For instance, an agent who sells you a ULIP may get 25% of your first years
premium, 10% in the second year, 7.5% in the third and fourth year and 5%
thereafter. If your annual premium is Rs 10,000 and the agents commission in the
first year is 25%, it means only Rs 7,500 of your money is invested in the first year.
So even if the NAV of the fund rises, say 20%, that year, your portfolio would be
worth only Rs 9,000much lower than the Rs 10,000 you paid. On the other hand, if
you invest Rs 10,000 in an equity scheme with a 2.25% entry load, Rs 225 is
deducted , and the rest is invested. If the schemes NAV rises 20%, your portfolio is
worth Rs 11,730. This shows how ULIPs work out expensive for investors. Deduct
the cost of a term policy from the mutual fund returns, and youre still left with a
sizeable difference.
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THE BATTLE OF THE REGULATORS
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SEBIs view
Ulips essentially marry two products: insurance, akin to a term plan, and investment, akin to a
mutual fund (MF). While as a package, Ulips have been regulated by Irda, Sebi now wants insurers
to get registered with Sebi before going ahead with further sales.
Their logic in doing so: The attributes of Ulips launched by insurers are different from traditional
insurance products and they are a combination of insurance and investment. The attributes of the
investment component of Ulips launched by these entities (the 14 companies) are akin to the
characteristics of MFs. The investment component of Ulips is subject to investment risks associated
with the securities markets, which are entirely borne by the investors. This establishes conclusively
that Ulips are a combination product and the investment component needs to be registered with
and regulated by Sebi,
IRDAs view
Irda chairman J. Hari Narayan says: Ulips are solely regulated by Irda, which has clear guidelines
on its distribution and investment. Ulips have been around for almost a decade now. Why has Sebi
suddenly woken up to claim regulation over Ulips?
He says: Irda has issued (guidelines to) these companies, who were served a notice by Sebi, to
continue selling. If Sebi wants to claim jurisdiction over Ulips, it first needs to sort out the matter
in a competent court of law. Once their jurisdiction is established, they can issue such directives.
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SEBI, IRDA cross swords over regulation of ULIPs
- The Economic Times, Jan 23rd 2010
MUMBAI: A turf war has broken out between the Securities and Exchange Board of India (Sebi) and
the Insurance Regulatory and Development Authority (IRDA) over the regulation of unit-linked
investment plans (ULIPs), which have emerged as one of the hottest investment products in recent
years.
ULIPs are insurance plans that are similar to mutual funds and have been around for a decade now.
The latest salvo from Sebi, the capital market watchdog, is a show-cause notice to all life insurance
companies, including the biggest player Life Insurance Corporation (LIC), that sell this product. The
inSebi's display of authority has not gone down well with IRDA. When contacted, R Kannan, member,
IRDA, said: "ULIPs are internationally sold by insurance companies and not by any other segment of
financial services. They are a composite insurance product, but the investment is shown separately
because the investment risk is borne by the policyholder."
"This product is structured as per international practice and is well within Section 2(11) of the
Insurance Act. We have asked for a copy of the show-cause notice and will take up the issue with the
government," he told ET. While the particular section in the Act recognises life insurers' right to sell
such products, Sebi probably feels the schemes that generate a return on investment are similar to
collective investment schemes which come under its jurisdiction.
ULIP is a generic term used to describe insurance plans where the choice of asset lies with the
investor. The structure is similar to that of a mutual fund. Just like in a mutual fund, ULIP money is
allocated to either an equity or income or balanced fund and any gain in the value of these assets is
reflected in the appreciation of the net asset value of the units. Charges towards insurance and assetmanagement are recovered from policyholders -- a practice that mutual funds also follow.
More than 80% of new premium collected by insurance companies from policyholders is in ULIPs.
The product is responsible for insurance firms emerging as dominant players in the stock market.
Under the circumstances, a curb on ULIP may also impact the stock market.
The move comes less than a month after the insurance regulator wrote to Sebi explaining that apart
from providing a maturity benefit, ULIPs also incorporate mortality and morbidity benefits, and,
therefore, come under the purview of the insurance regulator.
It is unclear what provoked Sebi a decade after ULIPs hit the Indian market.
However, with ULIP sales picking up, there have been shrill complaints from the mutual fund industry
that life insurers were selling mutual funds under the garb of protection plans. Fund houses argue that
insurance companies sell ULIPs by paying hefty commissions to distributors, while they are bound by
the maximum fee that can be given to brokers. Also, ULIP fund managers were turning into significant
players in the equity markets with equity assets under management of the life insurance industry
running into several billions.
Worldwide, there are not many instances of such regulatory dispute. One reason is that internationally
most insurance companies, which mobilise funds under ULIPs, farm out the management of these
funds into asset management companies that come under the purview of the markets regulator. In
India, life insurers are barred from using the services of mutual fund managers, even though almostevery life insurance promoter has a mutual fund within the group.
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TO CONCLUDE
A mutual fund is the ideal investment vehicle for todays complex and
modern financial scenario. Markets for equity shares, bonds and other fixes
income instruments, real estate, derivatives and other assets have become
mature and information driven. Today each and every person is fully aware
of every kind of investment proposal. Everybody wants to invest money,
which entitled of low risk, high returns and easy redemption. In my opinion
before investing in mutual funds, one should be fully aware of each and
everything.
At the same time Ulips as an investment avenue is good for people who
has interest in staying for a longer period of time, that is around 10 years
and above. Also in the coming times, Ulips will grow faster. Ulips are
actually being publicized more and also the other traditional endowment
policies are becoming unattractive because of lower interest rate. It is good
for people who were investing in ULIP policies of insurance companies as
their investments earn them a better return than the other policies.