Mutual Funds vs Ulips

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The intense battle between mutual funds (MFs) and unit-linked insurance policies (Ulips) was seen as a fight over regulatory control and product specification. However, in actual practice, it’s a fight over the control and access to distribution. Ulips have virtually taken over the equity investment market simply on the strength of their vast distribution network. They could afford such a deep penetration because the regulator allows them to pay generous commissions to insurance agents.

In contrast, the MF industry is facing a boycott from the distribution fraternity ever since the market regulator banned entry loads on MF schemes. This dried up the commissions for MF distributors as proceeds from entry load was their main source of income. Now there is hardly any incentive for distributors to sell MF schemes and majority of them have either shut their shops or switched to insurance, especially Ulips. This is quiet evident from the total premium collected by Ulip which is 75 times more than the net inflows from the retail investors in the MF industry in the FY2009-10.

The changes in the regulation have, however, not affected all MFs and insurance companies uniformly. Those with a bank parentage are on a better footing than independent MFs and insurance companies. Banks with their pan-India branch and ATM network can distribute investment products at a much lower cost than a network of independent financial advisors. This puts bank-sponsored firms at an advantageous position over others. The MF industry took off in India with the entry of private sector funds in 1993.

New entrants provided a greater choice to investors with new products such as ELSS, liquid fund and so on. The period coincided with the bull-run in equity market in late 1990s and equity MF became popular with middle class investors and the industry grew at a rapid rate. Life insurance, on the contrary, was a monopoly of state-run LIC for much longer. The private sector entry was permitted only in 1999 and new entrants took time to get their act together. These private sector players bought new and innovated products and Ulip being one of them. Most insurers in 2004 had started offering at least a few unit-linked plans.

Ulips, as an investment avenue, was almost similar to MFs in terms of their structure and risk-reward ratio. MFs with their longer experience initially held the market. However, it was a matter of time before insurance companies began to eat into the MFs market share. Insurance companies pushed Ulip by offering agents commission as high as 30 40% of the first year premium. This began to show results immediately and in 2005- 06, investment inflows in Ulips were at par with MFs Commissions of 2.25% offered by MF industry seemed meager in front of Ulip commission. Most of the individual financial advisors of the MF industry also started selling Ulips making distribution a major problem for MF industry. The only drawback being an insurance agent was that one person could only sell one company’s products and most agents began to dabble in both MF’s as well and Ulips. Push was higher on insurance side. This was quite visible with the yearly inflow figures. Premium from the Ulip almost doubled to a total of Rs 84,260 crore from Rs 39,434 crore in the previous year.

On the contrary, net inflow in the MF industry fell by 20% to Rs 30,000 crore. Private insurance companies generated almost 90% of the Ulip revenues. Financial year 2007-08 was a bull run for the Indian market and so for the MF as well as insurance industry flourished with more money flowing in. The major factors contributing to the growth was the booming stock market with an optimistic domestic economy. However, the global meltdown changed the scenario completely. It struck the MF industry hard. The equity inflows in the industry fell from Rs 40,782 crore to a paltry Rs 1,056 Crore. Both industries tried to make the distribution channel strong to gain business back.

But the decision of the market regulator’s Sebi to remove entry load from MF in August 2009 upset the industry’s apple cart. The new regulations dried-up distributor’s commissions and most of them shut their shop. The agents’ commission on insurance products, meanwhile, continued as before leading distributors pushing Ulips. Insurance became more prone to misselling by distributors. The reach of MFs to retail investors further declined and investment in MF declined further by 70%.

In FY10, the total premium from insurance industry grew by 21%, of which 45% is growth in Ulip premium. However, the MF industry faced further downfall. The total net inflow by retail investors fell by 65%. The total net inflows in equity, ELSS and balanced category was merely Rs 1,456 crore compared to Rs 4,084 crore accumulated in the melt down arena.

Though it is perceived that investment is need-based, but in reality, distributor’s ability to sell plays a big role in one’s investment decision. Distributors push the product where they see opportunity and profit. And right now, Ulips are far more profitable than MFs. But it would be wrong to write-off MFs completely. Ulips are relatively a new product compared to MFs. While equity MFs grew fastest in late 1990s, Ulips are merely six years old in India. Most investors are still not fully aware of the financial implications of investing through Ulips. In contrast, MFs is a well established product and easy to understand. As Ulips get older and investors start benchmarking them against MFs, the mist surrounding Ulips will clear.

In the long run, it is expected that MF’s will become an urban product and a new class of financial advisors distributing a balanced portfolio of traditional insurance products, MF and Ulips to their clients