How To Distinguish Between Insurance And Mutual Funds To Avoid Misselling

The rise in the equity markets, especially in the mid- and small cap space, has meant that investors are attracted to these areas to improve their returns.

Investors are being directed towards mid- and small-cap funds, and while too much concentration in a particular area raises risk, there is another element at play here. Not just mutual funds; there are a lot of other investments, including insurance policies, that are being sold as mutual funds. This is where investors need to exercise caution because they need to check the exact details of the investment before deciding on putting their money in there. Insurance companies offering mid-cap and small-cap plans in their unit-linked portfolios are different from your normal mutual funds. Here is how to distinguish such examples.

Mutual funds offer small-cap schemes and due to the sharp rally in the small-cap space these funds have done very well since March 2020.

However, the word small-cap fund does not automatically mean a mutual fund offering. Insurance companies offer unit linked insurance policies and these policies have a mixture of insurance and investment, as a part of the premium is allocated towards a fund and the performance of the fund will determine the payout on the policy. These policies also have a choice of funds which would include large-cap, mid-cap and even small-cap funds. Just because there is an exposure to small caps through such an option, it does not make the investment a mutual fund. The entity that is offering the product needs to be seen and that will give a better idea as to what the investment really is.

The most important aspect of the entire investment, as far as the investor is concerned, is to understand the actual investment and where it is going. Investing in a small-cap mutual fund ensures that your entire money goes towards small caps, as defined by the companies that are beyond the top 250 by market capitalisation in the country. On the other hand, when you take exposure to a small-cap fund in a ULIP, the features of the policy have to be followed. This will mean that there will be a premium that goes towards mortality charges. In addition, the various other expenses related to the policy will be deducted, and then the remaining amount will be invested in the fund. 

Another aspect that often seeks to mislead investors is the kind of comparison that is undertaken to show that there is a higher return that is earned by the small caps.

For example, comparing a large-cap index to a small-cap index over a period of time is most likely to see the small-cap index return being higher than the former. This will be especially true over the last several years, wherein the small-cap space has done pretty well. But this is not the correct comparison, as it leads the investors to assume that this kind of situation will continue forever. The most important aspect is risk, because the risk element in large-cap equities and small cap is completely different and could be too much for many investors to handle in the latter case. Choosing the right period for looking at performance in terms of market behaviour is also essential; otherwise, the picture that will be painted will be completely different, and the decision to invest will not be based on the correct factors. 

Unlike a mutual fund, where staying invested with the fund will ensure that the returns earned by the fund turn out to be the returns of the investor, the situation changes for a unit-linked plan. Here, there are many other factors at play, including expenses involved with the end result, so that even though an investor may have exposure to the fund, the end results that they see could be completely different. In addition, having a mixture of insurance and investments in a single product is not a great idea, and it is always better to separate the two. Whatever the decision of the investor, they should at least ensure that the basis for investing is based on correct information and that they are not being misled.