Before the market crash of 2008, ULIP’s were quite popular, but post the free fall most investors saw their returns being washed away. Thereafter the investor community started looking for options where they could invest but with a safety net. This is where the ‘highest NAV schemes’ comes into play.

With a ‘highest NAV’ promise, investors are getting lured into these funds assuming that they will get the ‘highest returns’. But does it really work that way? Read on.

How do they work?

These schemes come with a lock in of 7-15 years wherein you’ll be able to redeem your investments at an NAV which was highest during these 7 years. Let’s say, the NAV of the scheme was Rs 75 in the 6th year but during the time of redemption it comes down to Rs 65; however you will not be impacted by this fall since your investments will be redeemed at Rs 75.

You also have the option of choosing a suitable asset allocation—you can distribute 0% - 100% in equity, debt or money market instruments in any proportions.
Most companies tend to adopt capital protection strategies like Constant Proportion Portfolio Insurance (CPPI).  These models ensure that your fund takes only as much risk as needed to keep the final value of your portfolio intact. This could result in the returns being lower than market returns or in worst case scenario ensure only capital protection.  There is no free lunch after all!
The capital protection model decides the risk which the fund will be able to absorb given the interest rates in market and the duration. In the event of a downside, the company can hold onto equity only till that value where risk is completely utilised and then the whole fund will be transferred to debt.

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There have been cases when this got triggered closer to the market low and money got locked in to debt because the fund has to regain the lost money so as to protect the capital.

This is how it will work…

Case 1 – Market rallies higher and higher

In case the market does not recover back to the original high, then the product will outperform the market.  If on the other hand, there is a fall of 28% and subsequently the markets surpasses the earlier peak, the fund would underperform.

Case 2 – Market slides

 In this case, it is possible that market recovers the full fall and ends the 6th year with a significantly higher return, the investor would then lose out on the upside.

Key takeaways

• When should you invest? If money is invested when the market is rising or near to bottom the performance will be satisfactory since they start by investing first in equity and then transfer the same to debt on a market fall.

• When should you not invest? When the markets are nearing its high or there is a potential of drastic fall, then you should stay away.

• Who should invest? This fund is for those who want don’t want to be exposed to higher risk but are looking for a bit of capital appreciation along with safety. This can be used by investors who are new to the market and may be operating with insufficient information and expertise.

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• How much return to expect? The way this product is structured it should provide you with returns similar to balanced funds; somewhere between the returns that can be expected from debt funds and equity markets.  However, there are scenarios in which the fund can significantly outperform or underperform.

• How much is the risk factor? At the most an investor might not be rewarded with returns and at maturity he gets back only the capital invested.  The other risk is that the fund underperforms the markets.

• What are the drawbacks? The drawbacks are as follow

-Do not provide range of products depending on risk profile.
-Charges levied are higher than normal products.
-Capital protection or highest NAV guaranteed only at maturity.

So does this mean that this product class should be a complete no-no? One needs to understand an investment product before assuming anything about it. This product is suitable for those classes of people who want income from equity products but their risk appetite is not high. However do keep in mind that while highest NAV is guaranteed, the highest return isn’t!

Illustration: Vaibhav Shirke

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e-mail: Anil Rego

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