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Nath Balakrishnan

THE equity market, when it is all abuzz, has the magical quality of morphing into a honeycomb. Investors swarm it, lured by the prospect of high returns. It is no different now.

Investors — those that deployed funds directly or through the mutual funds route — have had a rich harvest of honey. Another class of investors that has reason to smile is the one that invested in equity-oriented schemes of unit-linked insurance plans. These plans enable investors track the performance of their net asset values everyday.

With companies having unit-linked products wasting no time to broadcast accomplishments, the advertising business is also abuzz. While mentions in business dailies are par for the course, it is not uncommon to see hoardings announcing the spectacular returns that such plans have delivered.

The temptation to get carried away by the hype can be irresistible, but now is the time to exercise some discretion. A look at how suitable the unit-linked plans are from an insurance perspective, and what factors investors need to consider.

High returns and sustainability

The high-decibel advertising campaigns may lead investors to believe that the returns generated over the past few months are sustainable. Nothing could be farther from the truth. To draw a parallel, similar advertisements were put out by mutual funds during the heady days of the market in the mid-1990s. For instance, campaigns with such punchlines as "100 per cent return in 10 months" were common. Investors who entered such funds were left high and dry when the market tanked.

Suitability of options

Unit-linked insurance plans usually offer three schemes: One oriented towards debt and money-market instruments, another with a tilt towards equities, and a third that seeks to achieve a mix of investing in both equities and debt.

If one opts for the plan that invests primarily in equity, the buzzing market could lead to windfall returns. However, should the buzz die down, investors could be left stung.

If one invests in a unit-linked pension plan early on, say 25, one can afford to take the risk associated with equities, at least in the plan's initial stages. However, as approaches retirement the quantum of returns should be subordinated to capital preservation. At this stage, investing in a plan that has an equity tilt may not be a good idea.

Fund management style

Considering that unit-linked plans are relatively new launches, their short history does not permit an assessment of how they will perform in different phases of the stock market. Even if one views insurance as a long-term commitment, investments based on performance over such a short time span may not be appropriate.

What has happened over the past few months is that such plans have participated in the broad-based rally in the market to deliver high returns. However, these returns are certainly not an index of what investors can expect in the future.

For instance, mutual funds posted spectacular returns in the mid-1990s and their net asset values (NAVs) zoomed. When the buzz died down, the erosion in value was equally swift. Quite a few funds have managed to recover from their battered NAV levels. Bluechip and Prima, now from the Franklin Templeton stable and then part of Kothari Pioneer, have recovered considerably to post annual returns of 25 per cent and 20 per cent respectively over a 10-year period. And this has been achieved on an asset base that has swelled considerably, especially over the past couple of years.

This ability to handle business downturns, maintain performance on an increasing asset base, and emerge unscathed is a reflection of the quality of fund management. And the same yardstick should be applied to evaluate insurance companies as well. Current evidence is inadequate to pass judgment on how they will stack up when the going gets tough.

Till such time they prove that they can deliver the goods under tough market conditions, investors will be better off opting for plans that invest primarily in debt, which have lower downside risk.

Market timing

To maximise returns even during such bullish phases, it is imperative that investors time their entry and exit from the markets. As far as stocks go, returns tend to be compressed over a short timeframe. (To illustrate, the Sensex has put on 60 per cent in a span of six months this year.) Staying put too long in a unit-linked insurance plan that focusses on equity may deplete returns if market mood turns negative. This implies that investors should deftly switch between schemes within a plan to get the biggest bang for their buck. For instance, investors who want to lock in to the gains on the equity portfolio can switch whole or part of their exposure to the debt-oriented plan.

Charges aplenty

Various charges are levied on such plans. They either lead to a deduction from the investment amount that is brought in or are adjusted by liquidation of units. In both cases, returns are affected. Typically, charges are high in the initial two years before they taper off and stabilise for the rest of the plan's term.

This would mean that the effective amount available in the first two years would be 80 per cent of what has been invested. Thereafter the investible surplus is higher.

In the current bull run, the high returns mask the charges levied. But if returns drop to single-digit levels, investors will feel the pinch.

One also needs to consider the deduction that will be made if one opts for life cover. If it happens to be on a one-year renewal basis, a higher amount will be deducted as mortality charges.

This is in contrast to what one pays in a pure term plan under which premiums are fixed on the basis of the mortality risk at the time of purchasing the plan.

Course of action

PROVIDING life cover is the most important function of insurance; providing returns is just an added advantage of such plans, which gets magnified, given the tax rebates. Investors can consider the following options:

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