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Capital Protection-oriented Funds (CPFs)

CPFs may lock-in money in an illiquid product but are a safe bet

Capital protection-oriented funds (CPFs) are under the spotlight. While the Securities and Exchange Board of India (Sebi) raised doubts over the quality of investments that CPFs make, two new fund offerings were launched — the JPMorgan India Capital Protection Oriented Fund, which is a 39-month close ended income scheme, and the Sundaram Capital Protection Oriented Fund Series-2, a three-year closed-end fund.

CPFs invest a large portion — 70-80 per cent — in fixed income securities, which mature on or before the scheme's tenure to preserve the investor's capital. The remaining funds are invested in actively managed equity portfolios for additional returns in a bullish market and downside protection in a bearish market. It works best for conservative investors, who are not likely to dip into their investments for the entire fund tenure.

A tilt towards debt makes CPFs comparable to monthly income plans (MIPs) and fixed maturity plans (FMPs). MIPs that pay investors dividends are open-ended hybrid funds, investing in both equity and debt. Those who opt for MIPs need to actively manage their debt investments, which can lead to an interest rate risk. FMPs may not be suitable for investors with a specific three-year time horizon. These schemes are limited to shorter tenures of one-two years. Such investors may not have many options other than a CPF. FMPs, which are pure debt, closed-end products miss out on the capital appreciation a CPF gets, due to its equity investments.

A CPF with its hybrid mandate provides an equity- and debt-portfolio package, without the inherent volatility of MIPS.

Return on investment

At present, the yield for triple A (AAA paper) three-year corporate bond paper is 8.5 per cent. So, returns from a CPF should be higher after additional gains generated by a fund's equity investments.

It is ideal for people who can't decide on their asset allocation and do not manage their portfolios actively. The debt portion of a CPF works like an FMP. Investors can lock in money at higher yields. However, the returns on CPFs are compromised, as the debt portion is not actively managed. Returns are also lower than those for MIPs or FMPs. Figures from fundsupermart.com show while MIPs and FMPs, as categories, gave an average of 6.85 per cent and 7.26 per cent return, respectively, the average third year return from five CPF schemes was 5.08 per cent.

Mid-term exits

Although CPFs are listed on stock exchanges, exiting before the maturity period is not easy. In the absence of a secondary market, investors need to sell it at a discount. An MIP, on the other hand, is flexible.

Tax benefit

High net-worth individuals in the highest income bracket (30 per cent) can benefit from the tax rebates that all the three categories offer. Investors can get inflation indexation benefits, and they are taxed at the rate of either 10 per cent without indexation, or 20 per cent with indexation. In addition, dividends accrued from an MIP are tax free in the hands of investors.

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