Struck by the popularity of mutual funds, insurance companies have been borrowing their terminology to roll out many NFOs or ‘new fund offers’ under their Unit Linked Insurance Plans (ULIPs) in recent times. When a ULIP fund is called Bharat Consumption Fund, Momentum Fund, Midcap Fund or Multicap Fund, it can be quite difficult for the investor to tell if she is looking at a mutual fund scheme or ULIP fund.

With parent companies for many insurers overlapping with those of mutual funds, this gets doubly confusing.

Most of our readers will already know the basic differences between the two. Mutual funds invest only in a portfolio of stocks, bonds or other assets, but ULIPs invest in a portfolio of assets, as well as a life insurance policy on your behalf. ULIPs have a five-year lock-in period, while mutual funds don’t. There are, however, at least five other differences between ULIPs and MFs that matter to your investing decision.

Labelling norms

After SEBI’s new categorisation rules in October 2017, there are very specific rules on what categories of schemes mutual funds can launch and what their portfolio composition should be. A large-cap fund, for instance, must invest at least 80 per cent of its portfolio in large-cap stocks, a mid-cap fund must invest 65 per cent in mid-cap stocks and focused fund cannot own more than 30 stocks.

The universe of large-, mid- or small-cap stocks is also defined for mutual funds. Every six months, AMFI puts out an approved list of the top 100 stocks by market capitalisation that qualify as large-caps, the next 150 that qualify as mid-caps and residual stocks that are small-caps. Mutual funds need to stick to these lists in their stock picking. However, ULIPs do not adhere to similar boundaries in their portfolios, as IRDA (Insurance Regulatory and Development Authority) has no specific categorisation or labelling rules. Thus, a diversified equity fund from a ULIP may invest 40 per cent in bonds. A bond fund may park 40 per cent in treasury bills. A flexi-cap fund may hold 20 per cent in bonds and a Nifty Alpha Fund may own 10 per cent in money market instruments. ULIP names are also not standardised. Therefore, a balanced advantage fund or mid-cap fund from one insurer may be a very different animal from that from another insurer.

Cost structures

To gauge the fees you are charged as a mutual fund investor, you need to look at only one metric – its Total Expense Ratio (TER). The TER is calculated on a mutual fund’s Net Asset Value (NAV) and includes distributor commissions, fund management fees and all other operational costs incurred by the fund manager. SEBI has set regulatory limits on TER based on the nature and size of the fund. The smallest equity funds can charge TERs of 2.25 per cent, which progressively reduces to 1.05 per cent when assets cross ₹50,000 crore. For debt funds, the TER starts at 2 per cent and declines to 0.80 per cent for the largest funds. TER apart, MFs can charge exit loads if you redeem your units within a specific time period. This apart, SEBI also requires mutual funds to offer all their schemes through a direct route where no distributor commissions are charged.

ULIPs, in contrast, charge over a dozen types of fees to investors, of which fund management fees, policy administration charges, premium allocation charges, surrender charges, guarantee charges are the most common. This apart, all ULIPs levy a mortality charge which goes towards your life policy. IRDA sets limits on the fund management fees (at 1.35 per cent per annum) and the overall costs that ULIP can charge investors, but this cap is defined as a ‘reduction in yield’. For ULIPs with a less than 10-year term, the difference between portfolio returns and investor returns (reduction in yield) cannot be more than 3 per cent. For longer policies, it cannot be more than 2.25 per cent. However, these cost caps apply only if you exit your ULIP after 10 years. If you exit earlier, your effective costs may be higher. The mortality charge on a ULIP is outside these limits.

There is also a difference in how MFs and ULIPs charge the above costs to investors. MFs charge the TER to the scheme’s Net Asset Value (NAV) and the disclosed NAV and returns are after the charge. ULIPs deduct some costs such as premium allocation charges and mortality charges from the premium you pay, charge some costs like fund management fee to the NAV and adjust some costs such as policy administration charges by cancelling some of your units every year. Therefore, your returns from a ULIP can differ from its NAV-based returns that you find in the pubic domain.

Ratings, benchmarks

If you want to select mutual funds, there are several rating and ranking services at your disposal that compare fund performance and assign ratings. These include businessline’s weekly Star Track ratings published in this newspaper, Valueresearchonline, Morningstar and others. You can also do your own research on trailing, SIP and rolling returns on portals like Advisorkhoj. This makes it possible for you to independently evaluate if a mutual fund is performing as it claims and is suitable for you. All this is also possible because of the standardisation of MF categories which makes schemes in a category comparable to each other. With ULIPs, Morningstar India offers publicly accessible ratings, but there are not too many other options. ULIPs may also not be strictly comparable to peers with the same name due to non-standard portfolios and allocations.

On benchmarking, SEBI insists on mutual funds benchmarking themselves to the total return indices specified by it. However, there are no similar rules around benchmarks chosen by ULIPs.

Disclosure, governance

Apart from daily NAV disclosures, mutual funds are mandated to make daily disclosures of their TERs under regular and direct plans, monthly disclosures of portfolios and assets managed and half-yearly disclosures of their accounts. ULIPs are subject to only annual disclosure requirements of their portfolio, asset allocation, investment strategy and returns. However, many ULIPs voluntarily provide quarterly or monthly disclosures.

Mutual funds are also subject to specific SEBI regulations to prevent insider trading, front-running and other such malpractices. While funds have found ways to get around these, SEBI’s skin-in-the-game rules ensure that fund managers and other key employees of mutual funds eat their own cooking. These rules require key personnel of AMCs to compulsorily invest 20 per cent of their CTC (cost-to-company) in schemes they directly manage or are associated with. This is apart from sponsors of mutual funds being required to invest ₹50 lakh or 1 per cent of assets in all new open-end funds. ULIPs are not subject to such skin-in-the-game rules.

Taxation

Except for one type of scheme (Equity Linked Savings Scheme or ELSS), investing in mutual funds does not fetch you any tax breaks. Your returns from mutual funds are taxed at your slab rate if they are paid as dividends. If they come to you as capital gains on sale of units, the taxation depends on the type of scheme. Debt-oriented mutual fund gains are taxed at the slab rate. Equity-oriented fund gains are taxed at 20 per cent for the short term and 12.5 per cent for the long term. Hybrid fund gains are taxed based on their asset allocation.

In the case of ULIPs, premiums paid can be included under the section 80C limit of ₹1.5 lakh a year and are exempt from tax to that limit. Maturity proceeds are exempt from tax if your annual premium is below ₹2.5 lakh and also does not exceed 10 per cent of the sum assured under the ULIP. They become taxable if the premiums exceed ₹2.5 lakh or 10 per cent of the sum assured. If you have multiple ULIPs, only maturity proceeds of policies with combined annual premium of less than ₹2.5 lakh are exempt from tax. The section 80C benefits, however, will not be available in either ELS schemes or ULIP premiums under the new tax regime.