Focus More On Downside Risk While Evaluating An Equity ULIP

Jun 01, 2018 | 6 months ago | Read Time: 4 minutes | By iKnowledge Team

Investing in ULIP

Credit: Pixabay

Buying and investing in insurance given the wide array of policies out there can be an excruciating task. Add to the mix the availability of Unit Linked Insurance Plans (ULIPs) and individuals find themselves in a financial bind about where to invest. While ULIPs can be a very lucrative insurance and investment plan, it is important to understand their composition and how to evaluate them to ensure you invest in a plan that is right for you.

What exactly are Unit Linked Insurance Plans (ULIPs)?

A ULIP is a life insurance product, however, unlike traditional and pure insurance policies, a ULIP gives investors the capability to insure and invest under a single integrated plan. This means that while you do have the risk cover of a policy, you can also invest in several qualified investments such as bonds, mutual funds, stocks amongst others. Aegon Life’s iMaximize offer individuals the ability to monitor their portfolios closely, however, the policy holder does bear all the risks associated with investing in the market.

Within a ULIP there are four basic funds which you can choose from before investing. These include equity funds (highest risk factor), income/fixed interest/bonds (medium risk), balance fund (medium risk) and cash funds (low risk). Your investment and protection portfolio and ULIP returns will all depend on your income, willingness and ability to take risks, along with the financial climate and your long term financial goals and budgets. Additionally, ULIPs are often very flexible, thus offering investors the ability to switch investments between funds to meet their changing demands and needs.

things to consider before investing in ulip Credit: Pixabay

What should I consider before investing in a ULIP?

As with any financial decision, it is important to evaluate and assess all the advantages and disadvantages of a ULIP for you before deciding to invest in it. Although it can be daunting to do so, remember most insurance companies offer several ULIPs and it is wise to find one that will suit your needs the best and give you the best returns. Given the vulnerabilities of the six investment funds offered by Aegon Life in a ULIP, perhaps the riskiest ones are equity funds, and hence, you need to be careful when investing in such funds. The ideal way out is to have a balanced portfolio with your investments lined up in debt and equity funds.

Now the most important question that arises is: how do I assess these investments?

While there are many ways to understand and assess the performance of equity investments, the most important thing to look at according to market experts is the performance of such a fund during a downturn in the market, that is whether the fund could protect downside risk.

evaluate risk of fund

Credit: Pixabay

How to evaluate downside risk of a fund?

To measure the ability of a fund in successfully protecting itself during a downside risk or a downturn in the market we can either use the downside capture ratio or maximum drawdown. The downside capture ratio measures the ability of a fund to perform in market-down periods. So, for instance if the downside capture ratio of a fund is 80, this means that the fund was successfully able to capture about 80% of the downside index (that is it has fallen less than the benchmark Nifty50 index) and protected downside risk. To fairly assess the numbers, you might want to compare the capture ratios to the average in the peer group of the fund.

Another measurement of a fund’s performance during a market downturn is Maximum Drawdown, which measures the maximum fall in the net asset value of a fund during the market downfall to the peak net asset value of the product.

Why focus on downside risk?

If we only focus on the performance of a fund during a bearish market, we get a very one-sided viewpoint of the performance of a fund. Often funds are guilty of showing higher returns from high risk portfolios during bearish markets to attract customers. If we fall into the trap of getting carried away by the high returns when a market is performing well without assessing how the fund will perform if/when the market falls, we are setting ourselves up for failure.

Failure to assess downside risk of funds also contributed to financial failure for several individuals during the 2008 market crash, where during the bullish years of 2006-2007 some funds outperformed others, however, once the market downturned, they fell much more significantly. To ensure your ULIP mutual fund provides you with optimal returns over a period, ensure you assess these factors carefully before investing. While a ULIP can be a very wise investment decision, you should know significant details about its performance, returns and much more before jumping into one.

Advt. no.: IA/MAY 2018/3999


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