Where the package is the value, ULIPs vs. Mutual Funds

There are many products in the world where the label or the packaging is what imparts value. The product in itself constitutes a fraction of the overall value derived by the consumer.

Take for example a Rolex watch, a Louis Vitton bag or an expensive bottle of wine. It is what the consumer percieves that is important as opposed to what is rational. If consumers were rational, they would probably be willing to pay only a fraction of the current price.

The case of Unit Linked Insurance Plans (ULIPs) vs. Mutual Funds is similar. While the former is an expensive vehicle to invest through, the latter is the best value rationally. However ironically it may be the case that investors derive more “satisfaction” in ULIPs as compared to Mutual Funds. The Mutual Funds do not promise a child’s education or a comfortable retirement or the highest NAV. Also due to the fact that most funds are open ended and periodically ranked according to short term performance, it encourages short term behaviour in distributors and investors. Hence the entire focus of investors is diverted from long term investment returns from Mutual Funds to short term volatility of the markets.

What is probably needed in Mutual Funds is a move towards interval schemes with Systematic Investment Plans and a defined investment horizon. These schemes would have an asset allocation which would be determined based on the target retirement date or the target education goals (the defined investment horizon). The investor would be assured that a systematic asset allocation will take away undue volatility and help in meeting life stage financial goals and at the same time benefit from the low cost structure of Mutual Funds.

It is probably a time for Mutual Funds and the regulators to understand the art of packaging!

‘Independent Directors,’ not so independent. Why?

In today’s Business Line, the columnist, Ashoak Updahyay, observes:

‘When Satyam imploded, most board members responded like ordinary investors – with shock and dismay at having been, well, cheated. A distinguished body of people with great skills and competence was as unable as the ordinary investor to discover, or prevent, for twenty quarters a promoter and his close confidantes from treating a publicly listed company like their personal fiefdom. In hindsight, they fell prey to the most common and ancient human trait – the need to conform.’

After having been fed with numerous write-ups on this big issue highlighting only the immediate cause behind the Satyam saga – the failure of the various bodies that are meant to safeguard every stakeholder’s interest – it is interesting to see somebody point towards the root cause – the perverse incentives, which discourage the individual participants from perceiving the status quo differently and pointing it out, especially, given that organizations/groups, generally speaking, subscribe to the act of killing the messenger, who brings the bad news.

Various parties involved are held responsible for not blowing the whistle, when the irony of the situation is that nobody was allowed to carry the whistles with them, let alone blow them…

An important implication that we can take away from this episode is to ensure that every organization puts in place a structure which seeks out dis-confirming evidence and brings them to fore. Because as human beings are driven by incentives, they will perceive things differently and act as devil’s advocate only when they are encouraged to do so and feel assured that they will not be subjected to the fate of Persian messengers, who were invariably killed, when they brought bad news.

It could be very taxing in the short run with no visible benefits but as somebody once observed, ‘it is easier to resist at the beginning than at the end.’ May be creating a system that encouraged diverse viewpoints could have prevented Mr. Raju from getting onto a tiger not knowing how to get down…