What are Capital Protection Funds

The term “Capital Protection Funds” sounds like music to investors’ ears. As the name suggests, a capital protection fund is a type of mutual fund providing FD-like protection and equity-like returns. In addition, it promises to return “protected” initial investment, that is, at least some portion of the initial investment, to an investor along with some capital gain if the investor holds the original investment until the end of the agreed term.

The Objective of the Capital Protection Mutual Fund

Its primary objective is to “safeguard the capital” of the investors in the event of market downturns and, at the same time, provide the opportunity for capital appreciation by participating in the upturns of the equity market.

Allocation of Capital Protection Mutual Fund

A capital protection mutual fund is a blend of fixed-income securities such as debt (especially zero-coupon debt) and equity investments. This type of mutual fund offers the investors the guarantee of principal amount partially through the fixed-income portion of the portfolio. Not only that, but the equity portion of the portfolio also gives the additional gain that increases the return. The protection of the principal amount requires the portfolio manager to structure the portfolio so that the capital gets protected.

How does a Capital Protection Fund Work?

These are close-ended hybrid schemes where most of the fund (typically about 80%) is invested in debt and money market instruments such as bonds, certificate of deposits, T-Bills, and other fixed-income financial instruments that give assured returns at maturity. The rest is invested in equity and equity-related instruments such as convertible debentures/ preference shares, warrants, equity derivatives and other instruments specified by the SEBI from time to time.

As per the mandate of the SEBI, these funds must ensure that the component of the fund invested in debt grows to the initial amount invested at maturity to provide capital protection. Besides, these funds must mandatorily be rated by a credit rating agency and must invest in instruments having the highest rating. Debt instruments are held till maturity to mitigate the probability of losses due to interest rate fluctuations.

Advantages of Investing in Capital Protection Fund

Investing in these close-ended hybrid schemes can be beneficial for those investors who fear the volatility of stock markets and yet want to take the opportunity of making gains. This mutual fund allows you to enjoy the benefits of investing in equities while keeping your principal amount safe. This fund is the best of both worlds as 80% of the fund is allocated in the highly-rated debt instruments, the remaining in equity. If the equity markets are on the rise within the tenure of three to five years, you could see your investments growing well. On the contrary, if the scenario is the opposite, your capital remains protected.

Limitations of Capital Protection Fund

The tenure of Capital Protection Mutual Funds usually ranges from 3-5 years, and there is no guaranteed return from the fund. The initial investment can only be paid back when the investors hold the fund until the guarantee period. The investor, who redeems before this period, has to bear any losses along with early redemption fees and fund charges. This type of fund also has higher expense ratios than other mutual funds.

When to choose a Capital Protection Mutual fund?

• When markets are volatile with medium to low inflation levels.
• Your risk appetite does not suit interest rate volatility risk.
• You want to participate in equities but avoid the associated risks.
• Your investment horizon matches the tenure of the scheme.
• You want more tax-efficient returns than Bank FDs.

Conclusion

Capital Protection Mutual Fund is an ideal vehicle for people having defined financial goals and who wish to safeguard a particular portion of their initial investments without missing out on the equity advantage to meet them. However, one should know that returns from this fund are assured but not guaranteed at any given point in time. For more helpful information related to this fund, consult a financial advisor.

That’s why Comparte Investment team asks do you have “Nivesh Ki Aadat”.

With this one can say “Mutual Fund Sahi hai”,  so let me do Nivesh