Maximum NAV does not Guarantee Maximum Returns

"Maximum NAV Guaranteed" is now the buzzword for insurance companies trying to outsell each other and lure the gullible investor.  Almost everyone has jumped to the bandwagon and this includes ICICI Prudential, Bajaj Allianz, Tata AIG, and LIC.  Here is my humble view -

• If the fund is investing in equities, it is very likely to go up and down with the stock market (Indian or international) and no fund can guarantee that it will give the highest index level over next xyz years.  The only way a guarantee product can work is that the fund will buy capital protection by selling futures (which caps the upside) or buying options (which comes at a cost).  The cost of buying options will be charged to the NAV of the fund and hence, the appreciation in the NAV of the fund will be less than the appreciation in the stock market.
• Alternatively, the fund will invest a part of the fund in debt and use the interest income from that portion to buy put options for the remaining part which is invested in equities.  Hence, the return will be lower than a pure equity fund if the stock market is a net positive over the investment period.
• The fund management company (or insurance company) will charge an additional fee for managing this fund and will further reduce the net earnings.  In addition, investment in these funds have a lock-in and one loses the guarantee promised if the investment is redeemed earlier.

An insurance company needs to protect itself from this risk and cost of this risk is eventually borne by the policyholder.  Any insurance product needs approval of IRDA and IRDA will not allow insurance companies to take this risk on their balance sheet since it will jeoparadize the entire industry.