Should you invest in capital protection funds?

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These closed-ended funds are good for investors averse to too much risks, but do keep in mind that they don’t really guarantee returns

Capital protection oriented funds (CPOF), as the name suggests, come up with the greater safety tag. Asset management companies (AMCs) keep launching such funds from time to time with both debt and equity components. Had it been only with the debt component it would have no difference with fixed maturity plans (FMPs) and mind you that FMPs sell even without the comfort of capital protection orientation. In case of such funds, while the equity component (around 20 per cent of the portfolio) gives participation in the potential upside, resulting in higher returns from the equity market, the crucial debt component (around 80 per cent of the portfolio) ensures capital preservation by virtue of the defined maturity date of these instruments. A number of fund houses have rolled out CPOFs including SBI capital protection oriented fund, HDFC capital protection oriented fund, Union KBC capital protection oriented fund, Sundaram capital protection oriented fund, JPMorgan India capital protection oriented fund and LIC Nomura MF’s capital protection oriented fund. There is no doubt that these CPOFs attract a large segment of investors who are averse to taking too much of risks. These funds are particularly attractive during economic downturn and in times of high market volatility. In developed countries, such funds offer capital guarantee with some upside participation. However, in India, these are closed-ended funds that offer only capital protection, without a guarantee.

“In case of investing in CPOFs, you know exactly when it will mature and when you will have the cash flows. So if you have defined financial goals, you may look at investing in CPOF. And once you invest in CPOF, you should not expect very high liquidity in the interim period. If you are not too sure about by how much or to what extent the equity market would move up and don’t want to take much risk, then you can possibly opt for this,” said S K Ray, a Kolkata-based independent financial adviser.

But then, one can also think of getting more or less similar payoffs by parking his funds in a fixed deposit or a public provident fund simultaneously with judicious exposure to large-cap stocks or call options. And if one is too worried about volatility in the market or interest rates, one can also mull investing in monthly income plans (MIPs) for some kind of plain capital protection.

Another simple way, as mentioned by another wealth manager, to protect capital without going through so-called capital-protection funds could be like this:

Consider you have Rs 100 to invest. You invest Rs 65 in debt and get, say, 10 per cent annual return. Therefore, you get Rs 6.50. You invest the remaining Rs 35 in equities and let’s say stock market goes down 20 per cent and therefore, you lose Rs 7. Going by this example, your net balance in hand after one year would be Rs 99.50 (Rs 71.50 + Rs 28). So your capital is almost 100 per cent protected.

There can be counter arguments also by some advisers, who would say that these are all shorter-term instances and these alternative plans should be compared with CPOF with the most suitable maturity period. For instance, there are plan A and plan B of series V CPOF by the same fund. While the maturity period of plan A is 1,825 days, the same for plan B is 1,100 days. One has to choose the most suitable plan for him/her, considering other factors.

But yes, there are chances of mis-selling here as well. The investor must be told in no uncertain terms that 100 per cent protection is not possible nor is there any guarantee. No investor should walk into such a fund knowing that an assurance has been made in black and white. An adviser who states anything to the contrary will do his client a great dis-service and it will surely go against the spirit of regulation.

Where, then, is the protection?

“In simplistic terms, the fund manager can take a three/five-year call. He gets a decent period of time to strategise efficiently. The risky bet, I must point out, is the equity portion of the portfolio. Imagine an MIP that has, say, a three-year compulsory lock-in, with its portfolio divided unevenly between debt and equity, with debt papers accounting for an overwhelming portion of the allocation. Such imagery, too, must be captured by the adviser,” said Nilanjan Dey, a financial planner and director, Wishlist Capital Advisors.

Dey said that one must keep in mind that the return on capital will not be guaranteed by the AMC. But, there will be an opportunity for reasonable protection. How does this happen?

“The fund manager asks for a lock-in. In other words, a CPOF requires you to keep your money invested for a certain period. In return, the fund manager tries to build a mechanism where a generous allocation is made to high quality debt securities. The rest of the portfolio (a small part) may go to equities – which potentially serves as a kicker (that is, a tool to augment overall returns). At the end, a CPOF should appeal to a relatively risk-averse investor, especially one who values his initial capital and yet does not mind a modicum of risk for the sake of returns. A well-managed CPOF may remain at the very core of such an investor’s tactical allocations,” he said.

The most important point to remember is that these are CPOF – that is, the orientation is towards capital protection and actually, there is no guarantee that capital will be completely protected. It goes with the regulatory spirit of “no assurances will be given to the investor”.

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