Indian equities remained volatile in the year gone by with the benchmarks scaling new peaks driven by select large caps even as the broader market suffered losses.
While that kept mutual fund investors on the edge, insurance products such as Ulips—schemes that usually give higher returns to policyholders as part of the premium money is invested in capital markets—or those that offer retirement solutions and have a low-risk profile and guarantee returns gained popularity.
But is it the most ideal alternative for mutual funds?
Vijai Mantri, chief investment strategist and founder Promoter at JRL Money, begs to differ.
“Both insurance and mutual fund companies are intermediaries through which you participate in the market. So, there’s no way in the world where one could say that insurance products are much safer than mutual fund products,” Mantri, who’s also the chief mentor at the wealth management company, said on BloombergQuint’s special weekly series The Mutual Fund Show.
Rather insurance products, he said, don’t offer the flexibility to withdraw money anytime as they typically come with a long-term lock-in period, which attract penalties on violation. Also, there’s severe underperformance in terms of returns.
On average, the internal rate of return of insurance products is 5.5-6 percent, while mutual fund industry has delivered a 2-3 percentage point superior performance historically by actively managing the portfolio on the fixed income side, Mantri said.
Watch the full show here to know more about Ulips and their alternatives…
Here are the edited excerpts of the interview...
In the last 2-3 months, I have heard personally of many instances wherein people have opted for an insurance product from a savings perspective and not from an insurance perspective over a mutual fund product. Now, may be nothing is wrong in that. What I urge you to do today is try and give us a sense of the kind of returns that come in, in both the products and whether the hot selling insurance product have an alternative in mutual fund family as well or not?
Sure, I will do that. It is very important to understand from where the return of either mutual fund or insurance company, or for that matter, any financial product comes from. Essentially the returns come from the capital market. So, it could be a fixed income product, it could be an equity product, it could be common in both of these products and return gets generated from that market.
Actually, it is not possible to have that kind of argument at all, but currently what is happening is that there is anxiety in people’s mind because the property market is not doing too well, equities have thrown their own challenges and the last refuge in the form of debt mutual funds had its own sets of challenges. So, I think this is the window which perhaps the insurance industry was waiting for too long. So, they just push their products saying that we give you guarantee, we give you assurance of the capital and we are far better solution compared to mutual fund product.
Both insurance companies and mutual fund companies are intermediaries through which you participate in the market. So, there is no way in the world where one could say that insurance product is much safer than mutual fund products.
Are you saying that those guarantee returns are untrue and they will not be able to meet?
They will be able to meet because they have to give guarantee to the Insurance Regulatory Authority of India. So they have to, when somebody gives guarantee they have to commit to it and they have to do it because once you give guarantee you have to provide certain capital and there are all kind of things that one needs to do but one needs to understand inherently that where the guarantee comes from. The guarantee comes from the inherent strength of the product.
Suppose if I am giving you guarantee it means I am underlying securities, cannot be equities. It has to be fixed income and it has to be highest-rated fixed income product. So, what insurance company would do in these kinds of products is to have a government securities product.
There have been two kinds of insurance products which have been at the forefront when it comes to savings a real product one is Ulips and one is retirement solutions sort which a lot of insurance companies give out. Are we essentially talking about these two categories right now?
Ulips are very different from retirement. It is just like mutual fund as far as its functionality is concerned because in Ulip nobody gives you assurance. So, Ulips have various plans, you have liquid plan, debt plan, balance plan, hybrid plan like balance fund and then you have equity, mid and large cap, all kind of permutations combinations which are possible in mutual fund product are possible in insurance. So, whatever underlying portfolio does, mutual fund or Ulip so you will get similar kind of return.
From a functionality perspective there is no difference between Ulips and insurance products. The advantages in Ulips compared to mutual funds are—one, in Ulips you have to commit for long term. So, suppose you are buying a Ulip product, you need to buy it for a minimum period of five years. There are some products which are single premium products, but we are talking about normal products, which is minimum five tranches that you need to put in money. After putting two tranches you cannot say that I am not going to put three tranches, you will have to commit to five tranches. Second, you can’t take this money out, if you take this money out there are penalties and all kind of things available.
Third, there is underperformance, there is nothing you can do about it. So, the only thing people are selling currently is because in Ulips you get tax benefit, because Ulip returns are tax-free but in Ulips one needs to have at least 10 times insurance cover.
So, Ulip products could be appealing theoretically to someone who is below 30, but the moment you are 35-45-year plus then the mortality charges itself and starts inching up so there is no difference between Ulips and mutual fund products.
I will urge you to try and compare the retirement solutions and the kind of returns they give versus products in the mutual fund industry and the kind of returns.
We will discuss that but before that I would like to explain that in most of the insurance communications, I am not saying that it is done by the insurance company, but the ground force which is selling the products generally they don’t communicate. There is very rarely standardisation of communication as far as return is concerned. So, we have seen people saying that you invest Rs 1 lakh right now and from 12th or 13th year we are going to give you Rs 20,000, saying that there is 20 percent CAGR, which is absolutely rubbish.
So, there is no standardisation of communication. There might be at IRDAI level but unfortunately it is not implemented properly. So, that’s one part of it. And many customers don’t understand the integrity of CAGR and IRR and simple return and all but what essentially is selling like a hot cakes currently is a simplified product where somebody says invest certain amount for certain period of time and after that time period gets over you are going to get certain amount fixed for next till your life and then you are gong to get certain lump sum when the person who has insured dies. So, this is one kind of product available. There is a regular income product available then within that there is one more product available where again you commit certain amount for certain period of time then you get one and half time or two time of that annual premium in form of that income for 10-12 years depending for how long you pay.
We looked at all these numbers and the returns are at least one and half percent inferior to normal mutual fund product. One and half percent inferior over a 24-year period is a hell lot of money. I will explain through the chart, there is a very simple product where insurance company is asking you to pay Rs 60,000 per month for 15 years and then you are going to get Rs 85,000 per month till your death and then dependent gets Rs 13 lakh and these are kind of SMS and emails you get from various people. So, I did an IRR and I looked at various combinations.
Suppose somebody is starting at the age of 25 put Rs 60,000 per month for next 15 years, so he is committing till the age of 40. From the age of 40 he starts getting Rs 85,000 per month till he dies. Suppose he dies at the age of 80 and at that age he is dependent to get Rs 12.97 lakh, the IRR of that product is 5.6 percent—that is the best possible combination you are investing for 15 years and then you are taking money out for 40 years. The moment you break this cycle the same person instead of dying at 80 suppose dies at 75, the IRR comes down to 5.4 percent and is the person dies at the age of 60, then the IRR comes down to 4 percent and if the person dies at the age of 50, the IRR comes down to 0.5 percent annualised return.
You can look it at other way round—instead of starting at 25 years of age, somebody started at 40 years of age—the best possible scenario is 4.7 percent, return which is little about saving rate. So, this is the kind of communication very cleverly feeding on the anxiety of investors and the insurance products are not where you can give money once or twice, it is a pretty long-term commitment. So, once you commit the money and there is a surrender value and there is pre-payment charges, there are various penalties of discontinuation or not fulfilling your promise, so when you get stuck with that then you had it and the sales force is so motivated in insurance companies.
Even today the first year commission is as high as 25-40 percent on many products. So, the sales team is hugely motivated that once I sell this product to my customer this is what I am going to earn immediately and then the customer needs to pay for next 10-15 years.
What about the alternative, we spoke about insurance and the kind of return that are coming here what about the alternative in mutual funds, I am guessing G-secs are the alternatives. What’s the typical kind of return you get in a mutual fund product which invest in G-sec?
So, I will give some illustrations. First let’s look at the history, it is very important to look at the history when we are going to look at the future. So, if you look at last 20 years of an insurance products and Ulip is a recent innovation—5-10 year kind of thing but 20 years ago people used to buy endowment kind of product and if you look at IRR of these products it is 5.5-5.7 percent I am talking about the interest rate in the economy of 13-15 percent. You are not talking about the economy where the interest rate is 6.5 percent. So, even in that era the interest rate was 5.5 to 6 percent maximum. In some products there are 7 percent IRR but by and large there are 5.5 percent kind of a return.
Now, look at the data for mutual fund industry and I will give you some magical number on Nov. 30, 2009, 10 year G-sec yield was 7.52 percent, so anybody who has invested for 7.52 percent for the next 10 year got 7.5 percent, assuming he is able to reinvest at same interest rate on the six monthly coupon. Now, you see from November 2009 till November 2019, 10-year period average G-sec return in mutual fund industry, even after paying anything between 1 and 1.5 percent, is 8.37 percent CAGR. 7.52 percent was a 10-year G-sec yield 10-year back. The mutual fund industry, let’s assume 1 percent expenses, is straightaway 6.5 percent. So mutual fund industry has delivered 2 percent CAGR over and above that in just last 10-years.
On an average, mutual fund has always delivered. Suppose, insurance has delivered 5.5-6 percent, mutual fund industry has delivered close to 8.5-9 percent return historically. So, 2-3 percent superior performance by actively managing the portfolio on the fixed income side.
What could happen now? I mean I want to bring up some of those examples wherein the kind of products that are typically being sold in the insurance space and if you believe they are more beneficial products return and flexibility wise in the mutual fund industry as well.
What is being sold currently is selling like hot cakes—you pay a fixed amount say Rs 1 lakh per annum for say 12 years and from 13th year you are going to get say Rs 1.75-2 lakh per annum kind of number for next 12 years. So it is a 24-year product. The IRR on these products come close to 5.5 percent to 5.6 percent. So, I looked at where the insurance companies are going to invest this sum of money. So, they are going to invest in G-sec, so if I have to look at 24-25 years from now, I need to look at 2044 G-sec maturity repo. So, 2044-year maturity current G-sec yield is around 7.4- 7.5 percent, you take out the fund running that 50-55 basis points as expenses. So, you have 6.9 percent CAGR let’s assume that suppose the interest rate in the economy is going to be the same. So, what happens in that kind of product?
So, suppose you invest Rs 1 lakh for 12 years and you withdraw Rs 1 lakh for next 12 years, but even after doing that the remaining corpus at the end of 24th year is Rs 22 lakh.
So, you invest Rs 12 lakh and you took out Rs 12 lakh, but the corpus is Rs 22 lakh. So, there is a better alternative available in the mutual fund industry. In insurance, IRR is 5.5 percent, in mutual fund industry even in G-sec fund the IRR is 7.9 percent net of expenses. So, that is the kind of options available in the mutual fund industry with a similar kind of security because it is just Government of India security.
There is also, somewhere in other examples, wherein you invest a lump sum right now and then withdraw certain sum at some point of time in future. Are there an alternative in mutual fund space as well?
Absolutely, suppose you look at the guarantee product in insurance. Let’s assume that you have a fixed one-time investment. Suppose you invest Rs 12 lakh in the beginning for instance on Jan.1. You can withdraw Rs 1 lakh per annum from 12th year onwards.
So, you invest at Rs 12 lakh, you withdraw Rs 12 lakh but at the end of 2044, 24-25 years from now, the corpus is around Rs 40 lakh and IRR is 6.9 percent. So, if you invest one time in the G-sec product which is maturing in 2044 there is an option available in mutual fund industry.
So these are the normal G-sec schemes on which the returns are. There is also third one where somebody invests say a lump sum right now and withdraws a much higher sum after 12 years as well but even in those instances returns are favourable.
Suppose somebody invests Rs 12 lakh right now. After 12th year the person can start withdrawing Rs 2 lakh per annum for the next 12 years. So, you invest Rs 12 lakh, you allowed that money to grow for 12 years and from 13th year onward you started taking Rs 2 lakh per annum. So, you invest on Rs 12 lakh, you took out Rs 24 lakh, but even after doing that the corpus available even after the end of 24th year is close to Rs 20 lakh. Again 6.9 percent IRR. So, very honestly if you are looking at investment, I don’t think insurance is the way.
Would there be a very limited number of schemes available which gives such returns and are there different alternatives out here? Frankly, G-sec funds for example are funds with necessarily not very long periods. Let’s say for example if somebody wants to invest in a fund which doesn’t have a maturity in 4-10 years, but has a slightly longer-term option available. What are the different slabs available and what are the kind of returns are there of?
Mutual fund provides you much greater flexibility. So, you have 2044 maturity G-sec fund available in the market, that has been offered by Nippon.
Nippon Lakshya Nivesh is one fund which I think as a structure is a wonderful product and 7.4-7.5 percent is the YTM. You take out 50 basis points as expenses, 6.9 is the net of expenses YTM for remaining 24 years, which is wonderful.
Beyond that you have constant maturity fund, which is 10-year constant maturity fund, outstanding track record over last 10-12 years, even in this challenging period. There were shorter duration G-sec funds, short term, which have 3-5 years maturity. So, it depends on what you want to do and my own research suggests me that 90 percent of the time a G-sec fund on the gross basis outperform bank fixed deposits and on net basis, net of taxes it outperforms five-year plus rolling returns. I have an FD and a G-sec security, then suppose five-year SBI FD is around 6 percent. You have five-year at G-sec around 6 percent plus. You get the coupon in bank deposit which is taxed, in mutual fund that coupon is not getting taxed. You wait for 3-5 years, you convert into long-term capital gain, apply indexation benefit, the tax incidence is much lower and you have flexibility.
Suppose in that year you have a long-term capital loss, you can adjust it with the long-term capital gain. So, mutual fund provides far greater flexibility in constructing the customers’ portfolio, but unfortunately these products are not reaching out to the customers because sales force on insurance side is much more motivated than on mutual fund side.
Would these returns be as dependable as what the insurance companies say that they are giving fixed returns?
So suppose, you are buying a G-sec fund, you are buying Government of India securities and if you question on that you can question on anything else. You question banks as well and from where the insurance companies are going to generate returns, they are going to generate returns by investing in underlying market only, but they provide guarantee and there is a huge cost of guarantee, why should you pay for that.
Almost everybody seems to be suggesting that this could be year of return of mid caps and small caps. What are the options available and why would you recommend or not recommend these funds?
We also tend to believe that mid and small caps should do well in 2020 but there is no guarantee. We took this call in the mid of 2019 and it worked but it is not necessary that it is going to work but our call is that large cap is not going to make big amount of money.
In the mid-cap space, our top recommendations are DSP Mid-Cap Fund, Invesco Mid-Cap Fund, Kotak Emerging Blue-Chip Fund and Mirae Mid-Cap Fund. On the small cap side, we have ICICI Small-Cap Fund, Axis Small-Cap Fund, Edelweiss Small-Cap Fund.
So, you can pick and choose to make your own portfolio but it is very important that in these funds you don’t do investments at one go. Even if you have a large sum of money please put that money in equity arbitrage fund or liquid fund and you should transfer that money in minimum of 12 months period because average is much better when you do a systematic way on a fixed frequency.
So, if you want to participate in mid and small cap please keep that in mind and second, be ready for volatility—return is there but after crossing the volatility. Most important thing, my big call again I am telling you, suppose you are investing for 10-20 years equity is definitely one product but also look at doing SIP in debt product, debt product SIP over a last 10-20 years has consistently outperformed gold return and in some cases even outperformed equity performance.
But that is only if you want asset allocation because I remember sometime back you were back on the show and you mentioned that, if you have a really long-term period in mind then equities have really outperformed by and large?
Absolutely, there is no question about it. I am saying equity is one part but what happens that when people see negative return in the portfolio the conviction goes out of the window and then they are searching for insurance.
And these funds that you mentioned the mid and small cap in the market, are these set of funds you recommending people to buy 3-4 funds in each category and not necessarily limit themselves to one fund?
Yes, actually when you are doing large cap you can do that in a couple of funds because large caps invest in top 100 ideas, so the return could converge over a period of time, but in mid and small cap I think it is important you should look at least 3-4 funds in each category. So, you should look at 3-4 funds and do SIP or STP structure and please review your portfolio regularly.
Also, you need to keep in mind that small- and mid-cap funds, the moment your CAGR crosses 15 percent plus, exit. Whatever people advise, it is time to start taking some money out of the table. No mutual fund adviser says take money out of table but I am saying so you should do that.
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