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Capital safety, modest returns

Structured products such as capital protection funds allow investors to gain an exposure to equities without the risk of a downside.

Tanvi Varma/Money Today        Print Edition: December 2010

If you had invested in equities in 2008, chances are you are still reeling from the losses. Besides, your real rate of return on any debt investment at that time would also be negative considering the double-digit inflation.

Given the current uncertainty in the markets, investment options seem limited, especially when you want to protect your capital while generating moderate returns.

Though higher returns usually come with higher risk, there are products that guarantee safety of capital with the possibility of an upside. Structured products invest in various financial instruments in accordance with your risk profile and objectives, and offer protection of principal if held till maturity.

Protection Strategy

Globally, there is a variety of structures that have the returns linked to an underlying portfolio, which could be stocks, bonds, futures and options of stocks, interest rates, etc. In order to bring these products to retail investors, mutual funds came up with capital protection products in 2006-7. How do these work? The capital guarantee is offered through a debt portfolio, which grows to the initial investment value at the time of maturity.

Capital protection funds should be considered when you need to reduce your participation in the stock market
"Typically, an allocation of 80% is made to debt, which can earn you a return of 7-8.5% from corporate bonds at present," says Sunil Subramaniam, executive director (sales and marketing), Sundaram Mutual.

"In effect, Rs 80,000 invested in a corporate bond for three years at 8% will have a maturity value of Rs 1,00,777. This covers your initial capital of Rs 1 lakh. The rest of the portfolio, 20%, is invested in an actively managed diversified basket of growth stocks, giving you exposure to the equity markets," he adds.

The percentage in the equity portfolio changes from the initial allocation according to the returns generated. In a bullish market, the asset allocation of, say, Birla Sun Life Capital Protection Oriented Fund, is similar to that of a balanced portfolio.

In a bearish market, the asset allocation is like that of a monthly income plan portfolio. These products are launched regularly and are available for tenures of three-five years. No exit option is available for these funds.

Wealth Management

The Indian market, too, has come of age and offers tailor-made products to its investors. Some of the most common among these are equitylinked or market-linked debentures, provided by many non-banking financial companies (NBFCs) and wealth management firms. Earlier, these were typically offered to high net worth individuals and came in larger ticket sizes.

Now, many companies are providing these products even to small portfolios worth Rs 5 lakh. These products are usually issued in the form of non-convertible debentures, which carry a fixed coupon rate and provide returns linked to the underlying stock or index. You may end up paying 4-5% for these structures, while the capital protection funds come with a lesser charge of around 2% per year.

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