2 Replies to “Which is the best Capital Protection fund?”


  1. UTI Capital Protection Oriented Scheme- Series I 3 years Plan (D)
    Sundaram BNP Paribas Capital Protection Oriented Fund-Series I – 3 yrs (D)

    Are two good capital protection schemes.

    — a mutual fund scheme that promises to protect your initial investment and gives better returns than a bank fixed deposit and other guaranteed products on offer. They target the need for safety of initial investment that has so far kept conservative investors out of the MF ambit and to provide returns attractive enough to lure them away from guaranteed return products.

    The performance of existing monthly income plans and hybrid debt oriented schemes show that funds are capable of generating superior returns with a high degree of safety. However, investors need to read the fine print on the protection of capital, liquidity, expected returns and risks before committing to these schemes.

    Sebi’s guidelines

    In August, market regulator Securities and Exchange Board of India issued guidelines permitting fund houses to launch “capital protection-oriented” schemes. Sebi says capital protection should arise from the way in which the portfolio is constructed and not from any guarantee by the asset management company or sponsor.

    It also requires that the scheme be rated by a credit rating agency on the ability of the fund to protect the initial investment and to be periodically reviewed on its continued ability to do so. Also, these schemes have to be closed-end, so investors can invest only at the time of the new fund offer and can redeem only on the completion of its term.

    The modality

    How do these funds aim to provide capital protection? A portion of the fund is invested in debt instruments that would mature at the value of the initial investment at the time of redemption. For example, out of Rs 100, Rs 80 may be invested in an interest-paying debt instrument or zero-coupon bonds, whose maturity value is Rs 100.

    The remaining Rs 20 is invested in securities that are expected to provide returns that make the investment proposition attractive. This is something that an investor can easily replicate by parking the funds in, let us say, a post office monthly income scheme and investing the monthly interest in the equity market. However, the advantage that fund houses would bring is the use of sophisticated tools such as constant proportion portfolio insurance and dynamic portfolio insurance to apportion and manage funds between less risky assets and risky assets.

    Unlike the example above, where the investment in equity was restricted to the cushion of Rs 20, the exposure to equity is leveraged with a defined multiplier. In the same example, if the multiplier is three, then Rs 60 (20×3) will go into equity and Rs 40 into risk-less assets.

    The protection is at risk only if the value of the portfolio falls below the floor, Rs 80, and this is monitored on a continuous basis with built-in triggers. This would ensure that investors are able to reap maximum benefits by participating in an asset class that gives better returns without compromising on the safety of the capital invested. The other advantage is that investing in a mutual fund is more tax efficient than investing directly.

    Buyer beware

    Capital protection funds are excellent tools for fund houses because they are able to tap into a source of funds that have so far been cornered by bank deposits or post office schemes. However, the investor needs to keep in mind certain issues before being carried away by the capital protection bit, which is what the fund houses and distributors will emphasise on. These are:

    No Guarantees. Sebi’s guidelines do not require the fund house to give any guarantees. In other words, the AMC isn’t required to make up the difference in case of capital erosion. They only need to ensure that, as far as possible, the investor’s initial investment is safe, by structuring the portfolio in a way that ensures protection.

    More importantly, these schemes aim to protect your rupee investment and inflation is ignored. This means that even if you get the Rs 100 that you had invested, effectively you have lost money because of the value erosion in the Rs 100 over the period.

    Does this mean that investors will lose money? Not likely. The closed-end nature of these schemes gives the fund manager the defined period benefit for making investments in debt instruments which ensure protection. The credit rating that Sebi insists on will also provide an added level of security for the investor.

    Low liquidity. Capital protection funds are essentially closed-end funds, wherein an investor can’t exit during the life of the scheme for any reason, be it need for liquidity, or poor performance by the scheme. The first capital protection fund in India, Franklin Templeton Capital Safety Fund, is mulling listing on the stockmarket to give investors an exit option.

    The experience of closed-end funds listing on stock exchanges has not





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