How do Highest NAV Guarantee Plans work ?

by Manish Chauhan on March 17, 2010

Now a days, we are seeing a new “Innovative” product in the market. They’re called Highest NAV
Guaranteed Plans .These products have come in, after the recent crash in the market, and
companies are taking advantage of the fact that Investors are looking for some kind of a safe
investment equity product. Hence, they’ve launched these Highest NAV Return ULIP’s which
confuse investors and make them (the investors ), believe that they are going to get the highest
return from the Stock market in long run – generally the tenure is 7 yrs, for these plans .
In this article, we look at how Highest NAV Guarantee ULIP’s work, and you will understand,
how any Guarantee product can be created by simple methods . The simple catch, here is that these
schemes, are structured in such a manner, that the collected funds can be invested either in equities,
debt instruments or in money-market instruments in proportions varying from zero to 100%

How Highest NAV Guarantee Policy Works ?

These plans use strategies like Dynamic Hedging and CPPI (Constant proportion portfolio
insurance), which are advanced strategies used in Derivatives world. But, let me explain a
simplified version of the whole process.
Supposing a policy starts today and is guaranteed to give highest NAV in next 7 yrs and we can
control how money moves to debt and equity, its pretty simple.
In the beginning, let’s assume a NAV of Rs 10, and the Asset allocation is 100% in equity and 0%
in debt . Now suppose, the market moves up and NAV goes upto Rs 15 by the end of the first year,
at this point, try to understand what Insurance company has to provide – they have to make sure,
that they provide at least Rs 15 as the return after 6 yrs . Now in order to achieve this, all they have
to do is keep X amount in debt instruments which will mature in next 6 years and provide Rs 15 at
the end of 6 yrs, so assuming the debt return at 7%, they need to put around Rs 10 in Bonds , so that
the maturity of the bond is Rs 15 at the end of 6 yrs .
=> 10 * (1.07)^6
=> 15.007
They can now invest the rest Rs 5 in Equity as Rs 10 is allocated to Debt . So, now they’ve made
sure that whatever happens to the market, they get Rs 15 for sure at the end of 6 yrs. Now, there are
two possibilities
Case 1 : Market Goes down : If market goes down, the NAV will go down correspondingly, but as
per the strategy, the maturity value will be at least Rs 15.
Case 2 : Market Goes up again : If market goes up at this point and the NAV rises above 15, for
example say to Rs. 18, now again they will pull out money from Equity and allocate such an
amount to debt, that the maturity at the end of total 7 yrs would be Rs 18 and so on…
Note :
• These highest guaranteed schemes do not provide wide range of product categories, such as
equity-oriented growth funds, balance funds and debt funds.
• Guarantee on highest NAV is available only if you survive the term. If you die during the
term, your nominees will get the prevailing value of the fund. This is inferior to even a
regular debt product because of the high cost structure involved.
Following is a pictorial description of how the Guaranteed NAV plan works with assumption
of a 7 year tenure.
How do Highest NAV Guarantee Plans work ?

March 17th, 2010 | Email This | Print This Post | 280 comments

by Manish Chauhan on March 17, 2010

Now a days, we are seeing a new “Innovative” product in the market. They’re called Highest NAV
Guaranteed Plans .These products have come in, after the recent crash in the market, and
companies are taking advantage of the fact that Investors are looking for some kind of a safe
investment equity product. Hence, they’ve launched these Highest NAV Return ULIP’s which
confuse investors and make them (the investors ), believe that they are going to get the highest
return from the Stock market in long run – generally the tenure is 7 yrs, for these plans .
In this article, we look at how Highest NAV Guarantee ULIP’s work, and you will understand,
how any Guarantee product can be created by simple methods . The simple catch, here is that these
schemes, are structured in such a manner, that the collected funds can be invested either in equities,
debt instruments or in money-market instruments in proportions varying from zero to 100%

How Highest NAV Guarantee Policy Works ?

These plans use strategies like Dynamic Hedging and CPPI (Constant proportion portfolio
insurance), which are advanced strategies used in Derivatives world. But, let me explain a
simplified version of the whole process.
Supposing a policy starts today and is guaranteed to give highest NAV in next 7 yrs and we can
control how money moves to debt and equity, its pretty simple.
In the beginning, let’s assume a NAV of Rs 10, and the Asset allocation is 100% in equity and 0%
in debt . Now suppose, the market moves up and NAV goes upto Rs 15 by the end of the first year,
at this point, try to understand what Insurance company has to provide – they have to make sure,
that they provide at least Rs 15 as the return after 6 yrs . Now in order to achieve this, all they have
to do is keep X amount in debt instruments which will mature in next 6 years and provide Rs 15 at
the end of 6 yrs, so assuming the debt return at 7%, they need to put around Rs 10 in Bonds , so that
the maturity of the bond is Rs 15 at the end of 6 yrs .
=> 10 * (1.07)^6
=> 15.007
They can now invest the rest Rs 5 in Equity as Rs 10 is allocated to Debt . So, now they’ve made
sure that whatever happens to the market, they get Rs 15 for sure at the end of 6 yrs. Now, there are
two possibilities
Case 1 : Market Goes down : If market goes down, the NAV will go down correspondingly, but as
per the strategy, the maturity value will be at least Rs 15.
Case 2 : Market Goes up again : If market goes up at this point and the NAV rises above 15, for
example say to Rs. 18, now again they will pull out money from Equity and allocate such an
amount to debt, that the maturity at the end of total 7 yrs would be Rs 18 and so on…
Note :
• These highest guaranteed schemes do not provide wide range of product categories, such as
equity-oriented growth funds, balance funds and debt funds.
• Guarantee on highest NAV is available only if you survive the term. If you die during the
term, your nominees will get the prevailing value of the fund. This is inferior to even a
regular debt product because of the high cost structure involved.
Following is a pictorial description of how the Guaranteed NAV plan works with assumption
of a 7 year tenure.

How Investors get Confused

You have to read in between the lines; Investors need to understand that these schemes guarantee
the “Highest NAV”, READ AGAIN! , it’s Highest NAV and not “Highest Returns” . Normal
Investors don’t give much thought before buying these products and normally assume that the
returns will be linked to the Equity Markets .
Do you Know , you can Now Subscribe to All the Comments on JagoInvestor !! (You can
Unsubscribe Later)

Returns from Highest NAV Guarantee Plans

So, what are the return expectations of these funds? We know, that long-term equity returns, are
normally in the 12-15% range while, debt returns turn out to be 6-7%. So, considering the fact, that
these products will shift most of their money to debt, by the end of the tenure , we can expect the
returns to be in range of 9-10%. We do get some equity upside in these products, but that will be
limited. After a point, this product will turn into a debt oriented fund with a major portion in debt .
Also if you factor in costs, like premium allocation charges , fund management charges and other
yearly charges, the returns will not be what you actually expect.
You will be amazed to know, that the returns expected from these schemes, may be lower than the
returns offered by equity-oriented Ulips. The reason being, that the basic objective of protecting the
previous high NAV of the fund, may constrain the fund manager’s ability to take risks while
allocating funds. So if the market has fallen down, the fund manager can’t take the risk of shifting
the money from Debt to Equity to gain from the potential upsides in future , because they have to
provide the “Guarantee.”

Source : LiveMint Research

Current Products in Market with Highest NAV Guarantee

• ICICI’s Pinnacle
• Birla Sun Life Platinum Plus-III
• Bajaj Allianz Max Gain
• SBI Life Smart Ulip
• Tata AIG Apex Invest Assure
• LIC Wealth Plus
 • Reliance Highest NAV Guarantee Plan.
• AEGON Religare Wealth Protect Plan

Controlling your emotions with these products

Let’s talk about mistakes from the investors point of view. We, as investors, don’t think with
inquisitive, susceptive minds. Getting good returns from stock markets is anyways a tough thing in
itself. So when these companies come up with plans like these, which say “highest NAV in 7 yrs”,
we have to ask, “How is this possible?” . Dont say it’s not possible at all, just ask how? How do
they achieve it? Stop seeing dreams of getting high returns without looking at the risk involved, and
try to find out – what is the strategy they’re using , Is there something in between the lines ?
We all want to get great returns, but we have to shed this belief that, companies come up with plans
specially for us. All the companies out there exist to earn money, and their motive behind every
product is to make money, & generate profits for their companies, so that they keep their
shareholders happy. So next time a product like this comes up , you have to control your emotions
before getting in and first investigate. The worst part of this whole business, (of guaranteed highest
NAV products) is the timing and how it gives naive investors, high illusions about the product.
Products like these, take major advantage of psychology of the ordinary saver. Many Investors in
smaller towns have broken their Fixed Deposits and taken some loan to invest in products like
these, especially SBI Life Smart Ulip and LIC Wealth Plus because of the trust factor with LIC
and SBI . See How Agents are Misselling LIC Wealth Plus

Why you should be “Pissed off” At these Insurance Companies

• Do you Know that, The Securities & Exchange Board of India (SEBI) , the stock market and
mutual fund regulator, does not allow mutual funds to guarantee returns. Therefore Mutual
funds can not provide guaranteed products which are related to stock markets, but IRDA can
approve things like these and all these insurance companies come under the ambit of
Insurance Regulatory and Development Authority of India (IRDA). So any Insurance
Company can come up with a new Plan , link it with market and start providing
“Guaranteed products” . You have to understand that “equity markets” and “guarantees”
are a very risky idea together , so please stay away.
• Do you observe when do all these “Innovative” products come up in Market ? The answer is
around end of the year, which is a premier Tax Investment time (Jan , Feb , Mar) . Is
innovation in Finance space limited to End of the year ? Why dont these products come
through out the year? Why ? The answer is simple , if it comes after anytime other than last
4-5 months of the Financial Year (ie Dec , Jan , Feb , Mar) , no body will bother to invest in
these, because no body is bothered to “invest” at all . Companies very well understand
investors psychology and their helpless ness at the end of the year because they have to
provide investment proofs for Tax exemption as soon as possible . This is not just limited to
these products , its true for NFO’s , IPO’s in booming markets , More Sales calls at the end
of the year, and other new products .
• The so-called “Guarantee” is a marketing gimmick and is implicitly a result of the way the
investment is structured . what it means is that the strategy they use itself is such that it will
provide you the highest NAV , even we can create our own Plan and do what they are doing .
But they make sure that Investors feel like they have done years of research and came up
with these amazing plans .
• Why The Tenure is 7 yrs ? I am not very sure on this , but here are my thoughts on
comments area
 • You have to understand that there is nothing “Innovative” in this product , the fact that 7
companies have come up with the same product proves that its not “innovation” because
Innovation is unique . Aegon Religare has gone ahead in this stupidity and introduced their
Guaranteed Plan which guaranteed 80% of the Highest NAV , Looks like they think that it
makes them look different from others .

Who should Invest in These Products ?

If you are looking for modest returns, like 8-10%, you can invest in these policies. The return of
these policies may be high in the beginning, if market does well; but when market starts performing
badly, the returns can take a hit and then be in a tight range. Your NAV will be protected for sure,
but the returns wont be, since over time the CAGR return will go down. Remember, if your NAV is
10 today and you highest NAV is 20, for a 2 year period, the return is a good enough 41%, but by
the 4th year it’s just 18.9% and by the end of 7th year it’s a measly 10.4%. So what you really need,
is protection of returns, not the NAV which is just a fixed number.

More reports on: Mutual funds

Highest NAV or marketing gimmick? news

12 April 2010

Investment products often guarantee the "highest NAV"; but they may not necessarily provide
the highest returns; rather they come with high charges, says Dhruva Raj Chatterji, research
manager, iFAST Financial India Pvt ltd, a joint venture between iFAST Singapore and
Deutsche AMC

''No matter how skillful you are, you can't invent a product advantage
that doesn't exist. And if you do, and it's just a gimmick, it's going to
fall apart anyway'' - William Bernbach, advertising guru
In recent weeks, there have been several advertisements of products
which guarantee highest value of NAV to investors. Such declarations
appear as a relief to the layman who neither understands the
intricacies of the stock market nor has the time to 'buy low and sell
high'.

The concept of protecting downside amidst market volatility is indeed quite interesting.
However, the devil lies in the detail.

Some of the important aspects of any investment product are the expected returns, investment
horizon, expenses and of course, your risk profile. Let us see how most of these plans work:
Although, the stock markets in India have been delivering superb returns since 2004, the
massive crash of -52.45 per cent in 2008 did cause panic amongst the market players and left
investors with colossal losses. No wonder that the retail investors have become wary of the
stock market volatility; hence, are increasingly looking at capital protection products.

As a result, portfolio insurance strategies of option-based portfolio insurance and constant

proportion portfolio insurance have garnered significance. The Highest NAV Guarantee plan
is based on the 'constant proportion portfolio insurance' (CPPI) model.

According to this model, the fund would invest in fixed income type of securities in order to
maintain a certain minimum unit value. When the fund value exceeds this floor value, the
surplus is placed into stocks. With constant rebalancing of the portfolio, the aim of the fund
manager is to not let the unit value fall below the base.

Similarly, the proceeds in highest NAV guarantee plans would be dynamically invested in
equity, fixed income and money markets instruments.

However, in a highest NAV guarantee plan, there is no specific asset allocation that the fund
manager has to adhere to unlike a mutual fund or a unit-linked insurance policy (ULIP). Since
highest NAV guarantee plans are a new product, there is no historical data to evaluate the
performance of these funds.

As the policy guarantees you the highest NAV, a fund manager may follow a conservative
approach and allocate your money into money market and fixed income instruments and
ensure that you get the highest NAV without much trouble. At the beginning, the NAV is 10
and let's say the fund has invested into equity. Suppose the stock market rises and NAV goes
up to 12.

As the fund has already made a gain of 20 per cent, the fund manager has to maintain this
NAV at least for next 6-8 years. Consequently, the fund would be rebalanced into fixed
income securities to ensure that the fund maintains the NAV of 12. Thus, even though the
fund manager may fluctuate from equity to fixed income or money market, the returns may
not be comparable to an equity diversified fund or a ULIP.

No easy exit
Insurance is ideally a long-term investment product expected to offer protection to policy
holder's family in the event of an untimely death or disability.

A whole life policy is typically designed for 15-25 years. In the absence of the policyholder's
income, the major as well as minor expenses of the family should be compensated through
the insurance cover. But the insurance component in highest NAV guarantee works merely as
a supplementary portion to the entire plan as these plans provide limited cover and most of
them offer guarantee at maturity after a period of 7-10 years.

Secondly, the highest NAV guarantee terminates past the grace period when you stop paying
your premiums. The exit from the plan or partial withdrawals is possible only after three-five
years.
Also, for partial withdrawals or surrenders that attract an exit charge of 0-20 per cent, this
guarantee is not applicable. Thus, these plans do not offer immediate liquidity.

No free lunches
Now, consider the actual investible part. These plans have five types of charges as shown in
the chart. The charges lie in the given range for products of different companies.

The units are calculated after deduction of premium allocation charge. So the balance from
premium received goes as an investment into the fund. Apart from initial charges, the
mortality, policy administration charges and fund management charges are deducted every
year from your fund.

There is a fund management fee plus a charge for highest NAV guarantee to assure that you
get highest NAV which would be deducted from your fund units. In totality, besides the
premium allocation charge, you would end up paying from your fund approximately 2.50%
per annum. In the later years, the premium allocation charges may come down but other
charges would remain.

Example
Assuming a person aged 35, pays a premium of Rs10,000 every year through an intermediary
into the plan. Let's say for a policy term of 10 years, the maximum permissible sum assured is
30 times the premium which would be just Rs300,000 and the annual mortality charge would
be approximately Rs500.

The table calculates your return considering Case I (assuming minimum charges applicable),
Case II (assuming maximum charges applicable) and Case III (assuming moderate charges).

Note: the tabular calculation os not consider the taxation

Monthly
Case Case Monthly
Condition Case I Income
II III Income Plan*
Account^
Premium 10,000 10,000 10,000 10,000 10,000
The premium allocation
12% 20% 15% 0% 0%
charge
Net amount 8800 8000 8500 10000 10000
Assuming NAV of 10, Not
880 800 850 1000
Units allocated Applicable
Annual charges priced in the NAV
Mortality and Policy
800 1220 1000 0 0
Administration Charges
Fund Management and
Highest NAV Guarantee 100 185 125 0 200
Charges
At maturity
Not Not
Highest NAV 20 12 15
Applicable Applicable
Fund Value 17600 9600 12750 15869 17447
^The fund value is calculated at 8% for 6 years
*The fund value is calculated using average historical performance of 15
MIPs at 9.72% for 6 years
We have considered monthly income plans of mutual funds as they have lesser allocation,
about 15 per cent-25 per cent to equity and post office monthly income account (POMIA) in
the table.

The POMIA gives an interest at the rate of 8 per cent, which is paid monthly as a regular
income avenue and is not cumulative in nature. At maturity, the deposit attracts a bonus as
well.

For simplicity, we have considered increase in value of deposit over six years. Also, we have
taken into account the average historical performance of 15 monthly income plans over five-
year period which comes to annualised 9.72 per cent.

Even though the fund NAV would rise by 50 per cent (as in Case III), the returns at the end of
the period would be lower than that in a POMIA and a monthly income plan (MIP).

Despite the Highest NAV assurance and a 20 per cent increase in NAV (as in Case II), after
deducting all charges, you are actually negative on your investment. In fact, your fund value,
net of all charges, should exceed almost 25 per dent in the first year itself to get your capital
back from the fund.

Only if the fund NAV were to double (as in Case I), would the performance better an POMIA
or MIP, even if not than the equity/balanced mutual funds or equity natured ULIPs.

Clearly, these products guarantee the "highest NAV" but they may not necessarily provide the
highest returns; rather they come with high charges.

The product may assure you of the highest value of NAV but the fund manager is restricted in
terms of investment decisions and may not be able to optimise the returns from the fund.
Investors who are risk-averse and have a seven-eight year horizon are better off with postal
schemes or bank deposits which have no charges and provide certain fixed returns.

For investors who prefer the equity flavor in their investments, monthly income plans of
mutual funds are a good option.

MIPs have an allocation of 10 per cent-15 per cent in equity with the remaining 80 per cent-
85 per cent in fixed income securities.

Also, the no entry load regime brings down the cost of your mutual fund investments to much
lower than these plans.

Besides this, to ensure that the family is adequately protected against unexpected and
unfortunate events, individuals can go for a whole life term policy which offers a better sum
assured value at minimal charges.