Share Market

In Mutual Funds, Assured Return Schemes are those schemes that assure a specific return to the unit holders irrespective of performance of the scheme. A scheme cannot promise returns unless such returns are fully guaranteed by the sponsor or AMC and this is required to be disclosed in the offer document.

Investors should carefully read the offer document whether return is assured for the entire period of the scheme or only for a certain period. Some schemes assure returns one year at a time and they review and change it at the beginning of the next year.

A powerful insight into assured–returns products is obtained by noticing that there is an option embedded in the product. When a fund sells a product where the unit holder receives all the upside potential, but his downside is capped at a fixed level: (a) the unit holder is getting a put option and (b) the fund is short–selling this put option. In order to evade itself, the fund needs to buy a put option, the price of which should really figure in every NAV calculation.

Assured returns schemes thus consist of Mutual Fund selling put options without hedging away that risk. This should make them exactly as uncomfortable as short selling put options on NSE’s upcoming options market. In terms of prudential regulation, regulators should be exactly as uncomfortable with a large short position on a put option market (which would require initial margin) as with a MF which assures returns (which has paid no initial margin).

Some investors look for investment options which guarantee them a fixed amount of return year after year because they believe they stand to gain without taking any risk. However, they could be exposing themselves to a much bigger risk – the risk of not keeping ahead of inflation.

This is why it may be sensible to have an investment portfolio that consists of more than just guaranteed return schemes. One can also consider investing in Fixed Income Funds. Fixed-income funds have the potential to earn a rate of interest commensurate with market interest rates. Credit ratings of companies are rapidly changing. Well-diversified income funds are able to spread this risk as research analysts are were equipped to track company credit rating changes. Investing through a bond/ fixed income fund does not mean giving up liquidity as is normally required with fixed deposits such as assured returns schemes.