It’s tempting to write a cheque for a mutual fund based on the low (or even no) entry charge. But you buy a financial product because you have a goal in mind, not because the charges are low. While charges and costs are important, the key to determining an investing instrument should be the net yield for the investor, calculated after assuming standard conditions of investment return and tenure.
However, there’s an ongoing debate regarding the charges levied by Ulips, especially the upfront charges. Critics say these charges are bad for the investor because they go to the agents as high commissions, which leads to mis-selling. But if we evaluate the Ulip product design, we see that the upfront charge actually benefits the long-term investor.
Most Ulips collect charges in the form of fixed upfront explicit charges compared with mutual funds, where the charges are mostly through variable fund management charges (FMC) which are implicit and back-ended. The fixed charges are levied either as a percentage of premiums or per policy (hence explicit) and variable charges are levied as a percentage of accumulated wealth and are deducted before ascertaining the NAV (hence implicit).
It has been proved that fixed upfront explicit charges combined with lower fund management charges result in a superior yield for the investor (as in many Ulips) than lower upfront charges combined with higher variable FMC (as in many mutual funds). From the business perspective, the upfront charges ensure that the expenses of managing the product are recovered early on in the product term. This lowers the cost of capital strain, which the company passes on to the customer in the form of lower overall charges.
The investor is also able to determine the target terminal value of investment with reasonable certainty. This is why it’s important for an investor to understand how charges are levied and not get carried away merely by competitive pricing.
— V Srinivasan is CFO, Bharti AXA Life Insurance
