ULIP Returns vs Mutual Fund Returns: A Comparison

Published: March 12, 2019 at 10:31 am

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In this article, I compare, category-wise, ten-year ULIP returns vs mutual fund returns. ULIPs are currently being sold as a “better alternative” to mutual funds because they are tax free. Investors by looking at the ULIP returns shown below must recognize the huge difference between the best and worst performer in each ULIP category. Since there is no way of know whether our chosen ULIP would fare near the top or near the bottom, buying a ULIP just for escaping tax is sheer folly as the exit is expensive.

Naturally, with mutual funds too there is a big gap between the top and bottom performer in each category. However, mutual funds do not have a lock-in (unless they are used for tax saving. Even in this case the lock-in is two years lower than ULIPs) and therefore the investor has the freedom to exit a poor performer without worrying about loss of life insurance benefits like the case of a ULIP.

ULIP Returns vs Mutual Fund Returns: A Comparison

ULIP Returns vs Mutual Fund Returns: Key Difference

What is a ULIP? A Unit linked insurance plan is a mutual fund where the insurer deducts life insurance premium from the available units in the fund. This statement alone should make you stay away from ULIPs!! If not, please recognize that this premium known as a mortality charge increases with age (unlike a term plan) according to the formula:

Mortality charge = mortality rate (for the attained age) x sum at risk/1000 x 1/12

Units will be deducted until the value of the ULIP fund is equal to or greater than the sum at risk (sum assured).

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mortality rate of a ULIP

Assuming we restrict ourselves to direct plans, mutual funds are subject to a fund management fee. This is comparable to the corresponding charge of a ULIP.

For a direct mutual fund, fund return = investor return
For a ULIP, fund return > investor return (as the units deducted for life cover are not included)

This means that the  ULIP fund returns shown below are a bit higher than what you will actually get. This is a key difference between ULIP and mutual fund returns.Now let move on to compare returns. The data is from Morningstar as on March 10, 2019.  The categories are defined here.

Assumptions and caveats

The comparison shown below are subject to several assumptions.

  1. It should not use them to prove that mutual funds are better than ULIPs are vice versa. That is not possible.
  2. It should use them to understand and appreciate the spread in both instruments.
  3. It is assumed that Morningstar categories of both are similarly defined. Evidence for or against this could not be found.
  4. Even though we consider only ten year returns, the fund could have changed investment strategy. I have not factored this in (as it impossible to determine).
  5. Category averages shown are of no importance as the underlying returns will not fall on a bell curve
  6. Despite these assumptions, the central conclusions of this article remain unchanged.

Aggressive Allocation: ULIPs vs Mutual funds

Aggressive Allocation funds invest across asset classes such as equity, fixed income and cash. These funds tend to make larger allocations to equities than Balanced Allocation funds. The allocation to Indian equities usually ranges from 65%–80% of total assets in the normal running of the fund. Morningstar Category Index: CRISIL Hybrid 35+65 – Aggressive Index

InstrumentCategory AverageTop PerformerBottom Performer
ULIPS12.7417.69.82
Mutual funds15.9420.2910.05

Conservative Allocation: ULIPs vs Mutual funds

Conservative Allocation funds invest across asset classes such as equity, fixed income and cash. These funds tend to make smaller allocations to equities than Balanced Allocation funds. The allocation to Indian equities ranges between 10-25% of total assets in the normal running of the fund. Morningstar Category Index: CRISIL Hybrid 85+15 – Conservative Index

InstrumentCategory AverageTop PerformerBottom Performer
ULIPS9.212.016.69
Mutual funds9.1611.586.63

Dynamic Asset Allocation: ULIPs vs Mutual funds

Dynamic Allocation funds invest into equity and debt in varying proportions. These funds have the flexibility to dynamically shift their allocation between equity and debt depending on the asset class’s attractiveness and manager’s view.

InstrumentCategory AverageTop PerformerBottom Performer
ULIPS9.912.785.59
Mutual funds17.3420.1314.38

Multi- Asset Allocation: ULIPs vs Mutual funds

Multi Asset Allocation funds invest across multiple asset classes such as equity, fixed income, foreign securities, cash and precious metal exchange traded funds, among others. These funds will invest at least 10% each in three asset classes and have the flexibility to shift the remaining allocation from one asset class to another depending on the asset class’s attractiveness and manager’s view.

InstrumentCategory AverageTop PerformerBottom Performer
ULIPS9.4611.577.1
Mutual funds12.7319.159.01

Large Cap: ULIPs vs Mutual funds

Large-Cap funds primarily consist of stocks which are the Top 100 stocks by full market capitalization of the equity market. These funds invest at least 80% of total assets in Indian equities and the balance can be invested in other asset classes such as fixed income and overseas equities, among others. Funds in this category would invest at least 80% of their total assets in large-cap stocks. Morningstar Category Index: S&P BSE 100 TR

InstrumentCategory AverageTop PerformerBottom Performer
ULIPS16.1220.4912.09
Mutual funds17.121.0213.55

Mid Cap: ULIPs vs Mutual funds

Mid-Cap funds primarily consist of stocks ranked 101st to 250th by full market capitalization of the equity market. These funds invest at least 65% of total assets in Indian equities, and the balance can be invested in other asset classes such as fixed income and overseas equities, among others. Funds in this category would invest at least 65% of their total assets in mid-cap stocks. Morningstar Category Index: S&P BSE Mid Cap TR

InstrumentCategory AverageTop PerformerBottom Performer
ULIPS21.0523.7317.46
Mutual funds22.7625.828.9

Multi Cap: ULIPs vs Mutual funds

Multi-Cap funds invest at least 65% of their total assets in Indian equities, and the balance can be invested in other asset classes such as fixed income and overseas equities, among others. These funds will invest into a mix of Large, Mid and small-cap stocks. Morningstar Category Index: S&P BSE 500 TR

InstrumentCategory AverageTop PerformerBottom Performer
ULIPS12.9517.38.83
Mutual funds18.6825.4512.83

We can see comparison for debt fund categories from the links below.

Summary

It is possible to observe a pattern between ULIP return and mutual fund returns. However, I would like to avoid taking this seriously. It is enough if we understand the spread in returns possible for both instruments. The big difference being, you are free to exit a mutual fund anytime you want and you do not lose out on life insurance cover (which if taken has to be from elsewhere). Despite tax free status, a ULIP does not have this benefit and therefore is inferior to mutual funds. The ULIP investor must live hoping their fund does not end up in the bottom quartile (25%), while the mutual fund investor can exit well before such a fall in performance.

References

  1. Morning Star ULIP returns
  2. Morning Star Mutual Fund returns
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Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice.
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1 Comment

  1. i guess mortality charge decreases with age in ULIP as the “funds at risk” decreases. Please correct me if wrong.

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