Highest NAV Guaranteed Plans

After the recent crash of the markets in the last few years, cautious investors were now looking for safe equity linked product (as mutual funds also fell to the same extent as markets). They wanted safe investments and also wished to enjoy high returns of the equity markets. Seeing this requirement of an unusual product, many companies launched schemes under the name of "Highest NAV Guaranteed Plans" to take advantage of those investors who burnt their fingers by investing in markets during the same period.

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 55 in the 6th year but during the time of redemption it comes down to Rs 48; however you will not be impacted by this fall since your investments will be redeemed at Rs 55. These products don’t actually offer what you think they are offering. That is, they do not offer equity returns that never fall. Instead, they offer an investment system with a very long lock-in (seven to ten years) in which protection is achieved by progressively putting your gains in a fixed income assets which will give returns far more slowly than a pure equity option .These plans use strategies like Dynamic Hedging and CPPI (Constant proportion portfolio insurance) techniques.

An example will give better understanding of the things.

At the Start of the Scheme

NFO issues the units at Rs. 10.

A part of the fund is invested in the debt market while the rest in equities.

Investments in debt secure your principal while in equities give you higher returns.

Thus the product as a whole is designed to give you safe and secure investments taking only a limited risk.

In the first Year, Market Rises

As the market rises, you earn profit on your equity investments, due to which your NAV rises

 (Say to Rs. 15).

As the company has promised highest NAV, a portion of these profits is again invested in the debt products to secure these high returns.

Therefore, the debt portion of your investments will maintain NAV at Rs.15 at the end of seven years. The remaining is again invested or retained in equities for further growth.

In the second year, Market Crashes

As the markets have crashed, the returns from the equities have reduced or there might be losses.

There is a fall in the NAV due to erosion in the portfolio from the equity investments (Say the NAV falls to Rs. 13).

To maintain the highest NAV, a larger portion of amount from the equities is transferred to the debt funds.

In the Third year, Market Rise

The returns from equities will increase, and hence the overall NAV will increase (Say to Rs. 18).

The allocation to debt portion will increase marginally to maintain the highest NAV.

In the fourth year, Market Crashes

There is a decrease in the NAV (Say to Rs. 16) due to a fall in the equity investments.

To lock up the highest NAV, a larger portion of amount from the equities is transferred to the debt funds.

Thus the proportion of the debt component in the portfolio goes on increasing each year while that of equities goes on decreasing.

After 3 years, at the end of the seventh year

Assuming this continues till the seventh year and at the end of the seventh year, our portfolio will predominantly comprise of the debt investments rather than equity (with which initially started).

Conclusion

The fact is that in a developing economy like ours, losing money in equities is difficult for investments having time horizon of over seven years.

However, the real reason for these funds to be ineffective is that practically any equity mutual fund would deliver this dream of equity-gains-without-losses for such a long period. Since at least 1997 the minimum total return that the Sensex has generated over its worst seven is 12 per cent, which was over the seven year period from 6th July 1997 to 5th July 2004.

It just reinforces one’s belief that financial products are being designed whose goal is nothing more than to create a marketing hype which can manipulate the psychology of the ordinary saver.

Expected Returns: This product is structured in such a way that 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 (in case of bear markets in the latter half of investment period) or underperform (in case of bull markets in the latter half of investment period).

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. The fund will underperform when the markets are low at the initial stages and then rise in the subsequent years.

Drawbacks:

·         Product does not take into consideration the risk profile of the investor.

·         Charges or commission are higher as compared to Mutual funds and other products.

·         Capital protection or highest NAV guaranteed only at maturity.

For whom this product is useful?

This can be used by investors who are new to the market and may be operating with insufficient information and expertise.

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.