Return - Illustrations, Assumptions: Mutual Funds Verses Life Insurance Policies..

Return - Illustrations, Assumptions: Mutual Funds Verses Life Insurance Policies..

by Mr. NARENDRA NATHAN



Investors' interest comes first for SEBI, and therefore it is well ahead of other financial market regulators on issues related to investor protection.

However, it is lagging behind the insurance regulator, IRDA, on two fronts.

First, it is on the disclosure of commission payable to the distributors. SEBI has already taken action on this front by enforcing disclosure of commissions through common account statement and the same will be implemented from coming October.

The second front where SEBI is lagging behind now is `one part' of the mutual fund advertisement regulations (ie where returns are `assumed' for illustrations).

IRDA has ensured that insurance companies use only 4%; 8% for illustrations. These values were 6%; 10% earlier, but IRDA brought it down because of the general fall in returns.

Since SEBI has not specifically fixed any rates for illustrations, mutual funds and distributors continue to use whatever rates they want.

SEBI's Guidelines for Advertisement by Mutual Funds clearly states that they should “avoid future forecasts & estimates of growth“.

Similarly, it also bans the portrayal of past performance “in a manner which implies that past gains or income will be repeated in the future“.

However, none of these rules has stopped mutual funds or the distributors from coming out with rosy illustrations.

This is because they are hiding behind the fact that these guidelines will not apply to “general messages“ (ie when there is no direct reference to any particular scheme or its performance).

While mutual funds usually use only 12% to 15%, distributors use close to 20% for these illustrations.

And in many cases, these illustrations compare possible mutual fund returns with that of other safe products like post office recurring deposit or / PPF.

For example, the final corpus of mutual fund investment `assumed to grow at 15%' will always be higher than the PPF that is `assumed to grow only at 8.1%'.

Since this kind of illustra tions can be used for mis-selling, Sebi need to act now.

Though publicity materials contain standard risk factors, mutual fund investments are subject to market risk, retail investors are not able to understand the risk fully.

And when the actual returns are significantly lower than the illustrated returns, investors don't understand that this is due the “market risk“.Instead, they feel cheated and leave the mutual fund industry forever.

That means, stoppage of such mis-selling (ie by projecting only the positive aspects) is crucial for `sustainable' mutual fund penetration in India.

How to implement this?

One way to do is to ask mutual funds also to use the same 4% and 8% imposed by IRDA now.

Mutual funds are going to oppose this. And their main argument against this rule will be that 4% & 8% are very low because mutual funds have delivered much better returns in the past.

However, we should not forget that mutual funds have given negative return also in the past, even after long holding periods.

So,  another way to do is fix a wider range, eg -10%, 0%, +10% and +20%.

And the retail investor will understand an illustration showing -10% returns much better than the current standard risk factors.

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