Protect your capital

Capital protection funds aim to protect your initial investment besides letting you benefit from any surge in the markets. Here’s how they do it.

Print Edition: October 16, 2008

The markets across the world are going through one of the roughest patches in financial history. If some of the most reputed investment banks and insurance companies can teeter and collapse, what hope is there for your investment? Little wonder that there has been a beeline for assets like gold and capital protection funds. But what exactly are capital protection funds and why have they suddenly found favour?

Capital protection funds are closed-ended funds with a maturity period of three or five years. They offer both dividend and growth options, with a minimum investment of Rs 5,000. For several years now, high net-worth individuals have had some or the other version of capital protection funds available to them. However, retail investors have been given this option only recently, with the first fund in this category launched in 2006 by Franklin Templeton. Today, many large fund houses are offering such schemes.

Gaurav Mashruwala
"Anybody can create his own capital protection fund by investing 70-80% in debt funds and the rest in diversified equity funds."

Gaurav Mashruwala, Certified fnancial planner

These funds are gaining in popularity because they not only keep your initial investment safe but also provide scope for your money to appreciate. How is your investment protected? At present, most mutual funds try to achieve this by investing a significant portion (70-80%) of the money in less risky assets such as high-rated debt instruments. The rest (20-30%) is placed in risky assets such as equity or equityrelated instruments. If the stock markets do well, your return from the fund is that much better; in a bear phase, you still get your money back from the bond investment.

“While the fixed income securities provide steady and consistent returns, the equity component enhances the return of the total portfolio for the investors,” says Nitish Gupta, fund manager, fixed income, Deutsche Asset Management. In line with the Sebi guidelines, each mutual fund house offering capital protection funds gets a credit agency to rate its portfolios on its ability to protect the initial investment.

So how are these funds different from fixed maturity plans (FMPs) or monthly income plans (MIPs)? After all, like capital protection funds, MIPs also invest 70-80% in debt and the rest in equities. The difference is that the debt component of MIPs work like a debt fund and is subject to interest rate and mark-to-market risks. On the other hand, capital protection funds invest mainly in bonds of fixed maturity and hold them till the end of the term. This protects the fund from the interest rate risk. It’s the equity component that provides the fund the potential for higher returns.

On the tax front, however, both types of funds are treated alike. The dividend income is tax-free in the hands of the investor. The long-term capital gains tax on redemption is 10% without inflation indexation and 20% with indexation.

So much for the good news. The not-so-good news is that experts and financial planners do not recommend these funds. This is because they don’t guarantee the safety of the capital; they only offer protection because of the way they are structured. Sure, there may be no interest rate risk, but there is still a credit risk. If a bond issuer defaults on repayment, the portfolio takes a big hit. Reinvestment risk is another concern. If interest rates fall after some bonds mature, a fund’s debt portion may not earn as much as planned. “If interest rates fall, they have to increase the proportion of debt to ensure capital protection,” says Zankhana Shah, a Mumbai-based financial planner.

The other problem is the returns. In the past year, these funds have managed to deliver an average return of 3.1%, far lower than the 8.16% offered by debt funds. Only one fund has given double-digit returns (see table). Apart from lower returns, you also pay a price for capital protection: a 2.5% expense and a lock-in period of three or five years. However, a year may be too short a term to judge the performance of these funds. Experts expect returns in line with debt funds in the next few years.

So, what should you do? Gaurav Mashruwala, certified financial planner, says, “Capital protection can be created at a much lower cost by individual investors. For instance, the debt portion (70-80%) can be invested in high-yielding FMPs, fixed deposits or PPF, which comes at a minimal or no cost. The remaining portion can be invested in a diversified equity fund or an ETF for market-linked returns.”

Besides mutual funds, the capital protection feature is also available in some Ulips like Kotak’s Safe Investment Plan, ICICI Prudential’s InvestSheild and the Capital Guaranteed Fund offered by TATA AIG’s Invest Assure. These sound good, but remember that capital protection is not on the actual annual premium but on that portion after deduction of various charges plus declared bonuses, if any. In fact, some insurers even offer a guaranteed return on investment. Aviva’s India Bond offers a guaranteed return of 7% for investments of 5 and 10 years’ tenure.

Scheme nameInception dateNAV (Rs)3 MTHS %6 MTHS%1 YEAR %Since inception
Birla Sun Life Cap Protection-3 yr (G)10 Aug 200710.490.631.442.893.94
Birla Sun Life Cap Protection-5 yr (G)10 Aug 200710.20-1.40-2.18-0.041.01
DWS Capital Protection1 Jun 200710.99-2.27-2.29
FT India Capital Protection-3 yr (G)19 Jun 200710.82-0.370.473.235.94
FT India Capital Protection-5 yr (G)19 Jun 200710.60-1.98-3.160.964.39
FT India Capital Safety Fund-3 yr (G) 2 Jan 200710.940.100.422.895.14
FT India Capital Safety Fund-5 yr (G)2 Jan 200710.61-1.69-
Kotak Wealth Builder Sr I (G)28 Feb 200710.98-0.221.897.716.23
SBI Capital Protection-(G)26 Dec 20079.52-1.73-2.08N.A-5.76
Sundaram Par Cap Protection Sr I-3 yr (G)
3 Sep 200711.23-1.630.7610.2310.73
Sundaram Par Cap Protection Sr I-5 yr (G)3 Sep 200710.52-1.09-2.861.822.78
UTI Capital Protection Sr I-3 yr (G)1 Mar 200710.83-0.81-0.131.725.14
UTI Capital Protection Sr-1-5yr(G)
1 Mar 2007
Data as on 12 September 2008

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