Fund managers in insurance companies probably save lesser tax than those in the mutual fund business. While both ULIPs and MFs invest in the same instruments, the way investors and analysts deal with the two is very different.
When corporate houses default on payments, analysts quickly offer tables and charts to represent the impact on mutual funds, since these funds are more transparent and have better disclosures. And when events like this happen, investors rush to withdraw their money from MFs.
However, there is hardly any research and analysis on how the debt funds of ULIPs are affected due to these defaults. ULIP investors do not behave like MF investors, who choose to redeem in panic. Debt funds of ULIPs, unlike mutual funds, are not subject to higher scrutiny by investors. Most insurers do not even disclose their entire portfolio. But this is not the only factor. The varied reactions to the defaults have a lot to do with the individual’s expectations from their investments in the two, the way the products are sold in the market, and the various regulations that govern them.
Why regulations matter?
The Insurance Regulatory and Development Authority of India (IRDAI) and the Securities and Exchange Board of India (SEBI) have similar norms when it comes to dealing with debt papers that face default or rating downgrades. Both MFs and insurers should have an onboard approved policy to write down the values of such papers.
When AAA-rated companies like DHFL and IL&FS stopped repaying MFs and insurance companies, the values of their papers were written down to zero. But MFs have better tools available with them to help them better manage defaults. And after a few defaults, SEBI introduced the concept of side-pocketing. This accounting method is used in a debt portfolio to split liquid and quality investments from illiquid ones. This helps small investors when their schemes witness high redemption. However, such options are not yet available with ULIPs.
MFs also have to stick to their mandates. SEBI has recategorized different funds and has defined what security fund managers can or cannot keep in their portfolios. It has also defined, for debt funds, the average portfolio maturity, depending on the category. For example, for short term funds, the duration of the product must be between one and three years.
When it comes to ULIPs, it is up to the insurer to stick to the fund’s mandate. Since interest rates are falling, debt funds in the short duration category in ULIPs have added 10-year government securities in large proportions, pushing up the average maturity of the portfolio as per the disclosures of the insurer’s portfolio.
The regulator has also imposed some restrictions on debt funds from insurers. The debt fund portfolio needs to have a minimum of 75% AAA-rated papers or G-secs in ULIP debt funds. IRDAI has also specified the list of instruments that these debt funds can invest in.
ULIPs also, like mutual funds, have restrictions on exposure to a single company, which is currently at 10%, and total exposure to a single corporate group, which stands at 15%.
The dominance of equity in ULIPs
Assets under Management of debt funds in the MF industry are higher as compared to equity funds. But in the case of ULIPs, it is the exact reverse. When an investor invests in ULIPs, it is primarily for equity. One in four investors put their money in the debt funds of ULIPs.
There are 16 categories of debt funds in MFs, that cater to different needs. Investors can use debt funds to park their money for a few days, or even for a few years.
ULIP investments are for long terms, with a lock-in for five years. Some even have liquid funds to meet the demand of the investors for the short-term parking of their funds. They are meant for those who want to manage their investment under ULIPs, which does allow them to switch from one fund to another.
Types of investors
Both of the above are focused on generating returns. But this is where all similarity ends. There lie major differences in the ways investors perceive the two products to be. As compared to ULIPs, MFs have greater disclosure. Additionally, mis-selling in ULIPs is also higher than in MFs, since the former pays higher distributor commissions.
According to financial planners, those who invest in mutual funds are usually savvier as compared to those who opt for ULIPs. Individuals who invest via ULIPs neither scrutinize funds nor check the returns, since information is also not that easily available. Many of them are not even aware of the funds that they select under ULIPs. They are unable to track the daily volatility of their funds, and can only check the returns in the communications that they receive from the insurer periodically.
It can also be challenging to understand a ULIP statement since it comprises of multiple entries that run into several pages. It is only at the time of surrender or maturity that they look at the returns on the premiums that they had paid throughout the term. On the contrary, mutual fund statements are straightforward to understand.
Mutual funds are in the limelight on defaults. This is primarily because investors can act on their developments. They can even withdraw and shift to other investment products. On the other hand, ULIP investors have very little choice. They need to pay premiums for a minimum of five years before they can consider exiting their investments.