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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.