Of all the markets, the financial markets are known to possess the least amount of integrity where the only ruling ethos is how to make money from the other person. A few months back you had intermediaries selling mutual funds and they would swear by them. Then came the regulator and made drastic changes in the commission structure of mutual funds so as to benefit the investor. The intermediaries got hit and so did the sale of mutual funds. However equity markets were still attractive so the insurance companies saw this as a great opportunity to sell investment products as insurance products. Moreover insurance companies were free to give handsome commissions to intermediaries and agents at the cost of investor. These companies understood the framing affects and the perception driven market to come out with a product and an advertisement campaign brilliantly named “Guarantee of the highest NAV”. The product was framed in such a way that the investor would fall for a guarantee of the highest NAV and invest.( the catch was that it was not the highest NAV of the market but of the investor’s own portfolio). The market having risen drastically from a sensex of 8000 to 16000 had made the investors fearful. However they were still greedy to make maximum returns. There was a great opportunity to exploit this greed. Moreover the intermediaries of mutual funds would be provided a new product with fat commissions to earn. It was a perfect setting to sell inferior products to the investor.
This is how the structure works:
1. The initial investments may be 100% equity or a combination of debt and equity depending on the strategy followed by the fund manager.
2. The fund manager follows a portfolio insurance strategy that can be done by allocating funds between debt and equity – Here the fund manager sells equity as the market falls, so as to protect the downside. Unfortunately the ‘guarantee’ on highest Nav does not allow for the reverse to happen i.e. to buy equities as the market recovers. This results in sub-par returns from the Equity portfolio.
3. Money removed from the Equity portfolio is invested in debt. The proportion of debt increases steadily and soon the debt part of the portfolio will become large enough to ensure the highest NAV.
A guaranteed NAV does not guarantee ‘equity linked’ returns. There is no way of knowing what the highest NAV would be and that NAV would probably have nothing to do with the stock market’s highest level during the same time. The so called guarantee is a marketing gimmick and is implicitly a result of the way the investment is structured i.e. with high proportion of debt. As an investor you are paying for such a guarantee, by accepting less than optimal returns.
Please evaluate your insurance needs and asset allocations before investing in any product. Understand your behavioral biases and do not allow others to exploit it. If you are greedy there is always someone to exploit that greed.