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Opinion

ULIPs lower management fees must be matched by performance

Agents are selling ULIPs (Unit Linked Insurance Plans) saying that they have WAY lower management fees and they will therefore, in the long run generate better returns as compared to mutual funds. HDFC Insurance for instance has a 0.8% management fees versus typically 2% fees by regular mutual funds. Now over the long run, says HDFC Insurance, the difference in management fee and lower entry loads will make a huge difference and lead you to greater returns.

They typically show you a spreadsheet showing a comparative analysis, taking 2.5% as annual management fees for a mutual fund (the max. a fund can charge) + 2.25% entry load for your yearly investment. On the ULIP end, they reduce all the annual charges – 0.8% management fee, some monthly fees and some commissions. Then they assume both funds will grow at the same rate – say 10% – and demonstrate how, at the end of 20 years, ULIPs will yield a better return.

They may be right, but only if returns from mutual funds and ULIPs are similar. Let’s run a check over the last three years, for the ULIPs that really have existed that long.

A pure NAV comparison:

It is obvious here that ULIPs have severely underperformed mutual funds. For a three year period, the best performing ULIP returned 159%, and the best performing ELSS fund returned 252%. In fact, HDFC’s own tax saving mutual fund returned 75% more (over three years) than its insurance growth fund!

I have not considered ALL mutual funds – only tax saving funds. The results are worse for ULIPs if you consider strong growth funds like Reliance Growth, SBI Magnum Global etc. I have also disregarded any shorter term than three years – it doesn’t make too much sense to compare in those terms.

If ULIPs are to really go away from paper spreadsheets and beat mutual funds as an investment product, they must pull up their socks and perform. Their claims of lower management fees only makes financial sense if they yield as much or better returns.

  • Dhananjay says:

    >Hello Deepak,
    While accepting the fact that ULIP’s would not match Equity MF’s in performance- whatever time frame we take – I would like to point out the following.
    1. ULIP’s give an additional insurance angle to your savings.

    2. Lets compare Apples to Apples (Even if its Himachal Apples to Chinese Ones)It probably would be better to compare the performance of ULIP’s to Debt Oriented Hybrid funds (Pru ICICI Income Multiplier Regular or even T I Pension)rather than diversified equity or ELSS funds. I am saying this coz these funds have a debt component like ULIP’s.The primary aim of these funds (As i believe for ULIP’s as well)would be capital preservation ie safety + some appreciation in order to beat inflation. This would throw ups a different conclusion about ULIP Vs MF returns.These funds would depend on time & compounding to give their returns like do ULIP’s.

    3. My third point is about the time frame used for comparison.3 years. For this type of product its too small.(I know ulip’s have been aroung only for 3 or so years). The last 3 yars have been exceptional equity wise. Over a longer cycle the debt component makes its presence felt(Many a time by pulling down performance). But I think we also have debt cycles in Mkt where debt returns are good maybe 10-14% & it is in these times ULIP’s may close up on MF’s.So I feel a truer comparison would emerge only after maybe a 15-20 year cycle.
    If ULIP data for US ULIP’s Vs US Debt oriented hybrid funds is available as i think ULIps have been around there for a longer period.
    4 The last point is that if it was as clear cut & dried as you make in yr post this Universal debate of ULIP’s Vs MF’s would not be raging everywhere. Also the MF people would have proved with figures one time that theirs is a superior product & closed the issue as ULIP’s take away a large chunk of their business.
    I guess Pundits & Analysts all over are mulling over these points & fell it would be unfair to conclude that MF’s are superior etc etc.
    Most importantly i feel the superiority of a product depends upon the need of the customer at that point of time. If ULIP’s (Insurance + beating inflation)are the customer need & he is getting his portfolio growth from say equities or Equity MF’s then for such a customer ULIP’s would be a superior product.
    Regards,
    Dhananjay

  • Dhananjay says:

    >A clarification,
    As i have been selling insurance for more than 7 years & MF’s for 7 months i probably have came out strongly in favour of ULIP’s.I would love guys to punch holes in my thinking in order that all of us learn some more & see a truer picture regarding this debate.
    regards,
    Dhananjay
    PS – deepak any input on my earlier post (Request) about SIP VS Lumpsum Vs Equity etc etc.

  • Deepak Shenoy says:

    >Dhananjay: Thanks for your points.
    1) I’ve compared only the investment parts (NAVs) – the insurance part can be handled by a term plan if you do the mutual fund route (overall long term cost is the same) Plus, if you look at the piddly insurance covers they give you it’s not even worth looking at the risk premium.

    2) I’ve compared the equity growth plans only. These are always shown to be better than mutual funds, hence the comparison. Even ELSS funds are not fully invested in equity – they do have 10-20% assets in cash/debt.

    I have now added HDFC prudence, a balanced fund (65% equity) which has nearly done what the ULIP “Growth” funds have done! Those I believe would by 80% equity or more.

    3) 3 years is all I have to compare with – otherwise I would have compared a longer term. Even in three years, i have had to eliminate half the insurance companies because they haven’t been around that long.

    Over the longer term equities actually outperform debt. There may be pockets where debt makes sense but historically over pretty much any 15-year term (in India) debt has made less sense than equities.

    4) The disadvantage in ULIPs is not really in performance – remember that can be fixed by better management. But it’s in the extremely high upfront costs. Now they say that averages out because of lower costs in later years, but as I find, the lower cost is more than matched by lower performance, keeping the net result a negative for ULIPs.

    I don’t think such high upfront cost products are useful for any investor, regardless of type. The alternatives provide the same risk and insurance ratios and do FAR better in terms of returns – so why go for ULIPs at all?

    I don’t ever recommend mixing insurance and investment. ULIPs are far better than endowments or moneybacks, but they currently look inferior to a term+mf strategy to me.

    I’ve written a lot about ULIPs, not all of which are flattering. What I would like to see is a product with less than 5% upfront charges, zero monthly charges and no reduction of units – all charges must be paid for through premiums, and no. of units must remain the same once allocated.

    Plus of course, I would like regulation to declare portfolios in detail every six months.

    about your earlier post: I haven’t had time to do this honestly, but you can get earnings details from nseindia.com and bseindia.com. There are also pages for splits and bonuses there, but it doesn’t go much further back than 1999.

  • Dhananjay says:

    >Hello,
    Regarding my earlier post,
    If possible Pls send link of exact location of split & bonus on NSE & BSE websites. I had already visited these sites but was unable to locate the exact pages you are referring to in your post.
    Thanks & regards,
    Dhananjay

  • Raj Gopal Vuppala says:

    >Comparing returns:
    It does not make sense to compare the returns of midcaps against largecaps. The midcaps should be compared against midcaps and largecaps against largecaps. This will help us identify the better performing midcaps to largecaps. For instance in the year 2004, the returns from micdcaps were extremely high compared to largecaps. If I look at the returns of largecap fund between Apr 2004 to Apr 2005, the returns are in the range of 6% to 24%. During the same period the retruns of some of the midcap funds are in the range of 49% to 70%. Based on pure returns we might interpret that an average performing midcap HDFC Capital Builder(which gave 49% returns) is better than one of the best performing largecaps HDFC Equity(which gave 24% returns which is more than any other largecap) for the same time period. Most analysts rely on Sharpe Ratio which is risk adjusted return which is a better parameter to rely on than pure returns. (The sharpe ratio is going to be high for well managed midcaps which is one reason I have a good portion of my investments in midcaps. But I donot ignore largecaps either and I donot compare largecaps against midcaps).

    Fund Management in ULIP:
    The investment advise for ULIP’s is actually given by the mutual fund AMC’s. This is true even for ULIP’s which donot have a mf wing. For instance
    Bajaj Allianz – DSPML advises them on largecap investments, Principal PNB advises them on midcap investments.
    MaxYorkLife – Franklin Templeton advises them on equity investments.
    Where to invest majorly depends on the research team and all these decisions are advised by mutual fund AMC’s for any ULIP. The returns in ULIP’s could be similar to that of the corresponding MF. Just to quote some examples:

    Apr 27 2004 to Apr 27 2005
    HDFC Top 200 – 21.78%
    HDFC ULIP – 20.46%

    April 27 2005 to Apr 27 2006
    HDFC Top 200 – 92.50%
    HDFC ULIP – 101.60%

    Apr 27 2006 to Apr 27 2007
    HDFC Top 200 – 13.15%
    HDFC ULIP – 6.61%

    April 27 2005 to Apr 27 2006
    SBI Magnum Contra – 120.47%
    SBI Magnum Global – 114.02%
    SBI ULIP – 125.37%

    Apr 27 2006 to Apr 27 2007
    SBI Magnum Contra – 9.80%
    SBI Magnum Global – 11.19%
    SBI ULIP – 13.60%

    ULIPS underperform:
    I do not think we can generalize the statement that ULIP’s severly underperform. SBI ULIP has given 156% return in the last two years, which is more than Magnum Global, Magnum Contra, Sundaram Select Midcap, Reliance Growth, HDFC Taxsaver and ICICI Taxplan. (I donot want to compare with largecaps though none of them gave so much return either). I only have two years data to compare for SBI ULIP.

    Similarly, HDFC ULIP has not been bad in its performance either. It gave more returns in the last three years than large caps from Sundaram, Franklin, Kotak, DSP ML, Nifty. (Only ULIPS which beat the performance of HDFC ULIP were HDFC MF’s since the research team is the same). If I go back by a year and compare the performance of mf’s and ulips as on 27th April 06 then HDFC ULIP gave more returns than any other largecap fun (including those from HDFC though by just 1%).

    All I am saying is we cannot draw to conclusions that performance of ULIP’s is bad since we have limited data.

    Here is the spreadsheet that I had used with NAV’s for comparing returns. I have compared midcaps seperately from largecaps.

    http://www.thinkfree.com/view.tfo?file=R9IRvgYXV7Y=

  • Deepak Shenoy says:

    >Raj: Thanks for your comment – I don’t agree about the midcap/large cap bend. Firstly there is no portfolio revelation of the ULIP that says they’ve invested in midcaps or large caps. Secondly even the mutual funds have varied portfolios, containing midcaps and large caps, which changes practically every day. If you take the sharpe ratio or betas of these funds you’ll find they are comparable with the ULIPs)

    Secondly there is no risk difference between largecaps and midcaps. I know everyone thinks otherwise but the risk is exactly the same: high.

    You may be right about the fund management sharing between MFs and ULIPs, but the difference seems to be obvious between the two! In a three year span at least.

    I wouldn’t take the last year into consideration. Remember that in July last year ULIP rules changed dramatically and therefore in June the highest amount of investment came into ULIPs (to take advantage of the old rules) This coincided with a low on the markets, which is why they have marginally outperformed MFs in the last year.

    SBI Ulips are too young, they need time to analyse. But even then, let’s compare it with their tax saving fund – Magnum Taxgain. That fund gave 15.7% in one year and around 150% in the last two years. THe reason you must compare with Magnum Taxgain is a) the tax advantages are the same and b) they have similar lock ins (so no redemption pressures)

    SBI ULIP hasn’t lasted long enough to make a decent comparison btw.

    Tax saving funds have actually underperfomed funds like Magnum Global in the last three years. That may be because there are not many ULIPs that have crossed three years.

    Okay, let’s wait for SBI ULIP to do the three year limit and then compare (again, with Taxgain) and see. I would actually wait a four year period – because then the redemption pressures start to show. But three years is still fine.

    I would wager that ULIPs will still underperform over the next year. And they will be subject to HUGE redemptions once their three year lock ins are over, because people are not very happy with the returns – since it’s not just the NAV growth that is lower, it’s also that their return, net of commissions and charges is much lower than a comparable MF strategy.

    I don’t disagree with your spreadsheet – good job there, but I think the only good thing that comes out of it is SBI ULIP. HDFC’s offering has underperformed its own tax saving funds over longer terms. Let’s see about SBi after its three years.

    While SBI is the only ulip that has shown a decent performance, its charges then hit you hard – 25% in the first year, 7.5% for two more yrs, 5% for two more and then 2% onwards – so net of management charges and these charges you will find a subdued return in comparison.

    The Single premium seems much more interesting – just 2% upfront.

  • Raj Gopal Vuppala says:

    >xHi Deepak,
    Regarding midcaps/largecaps … during a bearish phase, the midcaps always correct more than largecaps(only exception has been in 2004).

    I still beleive than one should not compare midcaps performance against largecaps, but then these are just my thoughts.

    Let us reanalyze the performance of ulips/mfs , midcaps/largecaps after a year or two when we have more data. This might spell more clarity on the performance.

    One thing that cannot be denied is that the high front end load is a big negative for ULIPS. Reliance and Bajaj have come up with ULIPS which have only 5% front end load.
    And ofcourse as you said there are the SP ULIPS(which I am not a big fan of since I treat them as lumpsum investments).

    -Raj

  • Amit Kulkarni says:

    >ULIP Companies publish their portfolio once a month or quarter. If I were to replicate that portfolio using the balance left over after purchasing term plan, then my investments would zoom past the ULIP fund performance. Any comments on this?

  • Deepak Shenoy says:

    >amit: true, you can do that, if the fund doesn’t churn too much (changes investments multiple times every month)