More and more mutual fund (MF) houses are coming out with capital protection oriented funds (CPOFs) with the promise of reducing the risk in your investment portfolio.
Some insurance companies, too, offer similar products, such as capital protected unit-linked insurance plans (Ulips). Ulips offer investment with insurance. So, if you are adequately insured, there is no point investing in them at higher cost and lower returns.
When the market regulator, the Securities and Exchange Board of India (Sebi), gave its go ahead to CPOFs in August 2006, it directed that these schemes be "oriented towards protection of capital" and "not guaranteed returns". Therefore, CPOFs don't guarantee capital protection and returns. As the name suggests, their main objective is to prevent capital erosion. Franklin Templeton fund house and UTI Mutual Fund (MF) were first off the blocks with their schemes in October and December 2006, respectively. Now, CPOFs are in vogue again. "As the fund invests in highly-rated instruments, it ensures investors of at least capital protection at the time of maturity," says Ashwin Patni, fund manager, IDFC Mutual Fund.
How it works
CPOF is a structured product which invests a larger part of its corpus in debt so that, at maturity, it becomes equivalent to the invested amount. The remaining corpus is invested in equity to boost returns. Usually, CPOF comes with lock-in periods of three years and five years.
The shorter the maturity period, the lower the equity exposure and vice-versa. Let's take an example. Suppose, you invest Rs 1 lakh in a CPOF with the maturity period of three years. The fund will invest Rs 83,500 in debt instruments, which will become equivalent to the amount invested (Rs 1 lakh). The rest will be invested in equity instruments.
The rationale behind this is that if any volatility occurs in the equity market, your capital is protected. And if all goes well, the equity component in the portfolio will boost your returns.
How it Scores over others
Similar products like balanced fund and monthly income plans (MIPs) are doing quite well, except that they don't offer capital protection. But does it make sense to invest in them when the equity market is doing well? Another moot question is why were these products not launched when the market was facing turbulence in 2008-09? Historically, these products are launched when all is well with the market.
Balanced funds may not be a good option for conservative investors because they invest 25-30 per cent of their corpus in equities. Debt-oriented MIPs, which ALSO invest around 10-15 per cent of their corpus in equity and rest 85-90 per cent in debt, are best suited for such investors. MIPs have scored well over CPOFs on other parameters as well.
Returns
MIPs have delivered 17.63 per cent, 7.97 per cent and 9.12 per cent returns over1-year, 2-year and 3-year periods, respectively. On the other hand, the average return of CPOFs is 15.76 and 8.63 per cent in the last one year and three years, respectively.
Since none of the funds in this category have completed their full term, it is difficult to ascertain the actual return after maturity. UTI Capital Protection Oriented Scheme-Series I-5 Years leads the pack in this category with the return of 24.35 per cent in the last one year.
Taxation
Since it is a debt-oriented product, it's highly tax-efficient in nature. Due to the lock-in clause, they don't allow premature withdrawal by investors. Therefore, those seeking liquidity should opt for the dividend option, as dividend is tax-free. On maturity, if you haven't opted for indexation benefit, you would need to pay a flat 10 per cent tax on your gain.
Liquidity
Despite being listed on the stock exchanges, CPOFs are not very liquid. If you want to exit from before maturity, you may have to sell at a discount due to lack of buyers.
If you are die-hard conservative investor and don't want to take chances on your investment capital, they could be a viable option for you.
