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Capital Protection Oriented Funds

 

Capital Protection Oriented Funds

 

Erosion of capital is one of the key concerns for investors wanting to invest in equity mutual funds.


To address this concern, asset management companies have launched Capital Protection Oriented Funds (CPOFs).


What are CPOFs?


CPOFs are generally three to five-year, closed-ended funds where 70-80% of the portfolio is invested in fixed income securities, which mature on or before the scheme's tenure. The investment in fixed income securities grows to 100% at the end of the tenure, providing the investor with capital protection. The remaining portion (20-30%) is used to take exposure to equity, which provides the upside. Exposure to equities is either by directly buying equity stocks (plain vanilla CPOFs) or by buying nifty call options (leveraged CPOFs).


Plain vanilla CPOFs:

These have an asset allocation com parable to monthly income plans (MIPs) which have a similar investment pattern. A crucial difference, however, is that an MIP is an open-ended fund where the fixed income portion is actively managed. Hence, an MIP does not provide capital protection like CPOFs. A plain vanilla CPOF with its hybrid mandate thus provides an equity and debt portfolio package, without the inherent volatility of MIPs.


Leveraged CPOFs:

These are comparatively a new concept. These products continue to invest 70-80% in fixed income securities for capital protection. The remaining portion is used to buy nifty call options with tenure matching the maturity of the fund. The leveraged nature of options helps these funds to participate to the extent of 80-100% in the upside of nifty during the tenure of the fund.

 

For example, if nifty delivers 50% returns during the tenure of the fund, these funds would deliver returns of 40 50% depending on the level of participation provided to the investor. The flip side is that if the equity market does not move up or is negative after the tenure, the investment in nifty options would be rendered worthless and the investor would get only the capital back at maturity. In such a situation, it would have been better to invest in a plain vanilla fund, which would have given relatively higher returns.


Poor liquidity CPOFs are suitable for conservative investors who are not likely to dip into this investment for the entire tenure of the fund. Those who expect the equity market to move up during the tenure of the fund but are not sure of it, would find these funds useful.

It is important to note that liquidity in CPOFs is very poor. In case an investor requires money before the maturity of the fund, it's difficult to exit. While these instruments are listed on the exchanges, the possibility of finding a buyer is low.

What are the tax benefits available?


Investors can get inflation indexation benefits and they are taxed at the rate of either 10% without indexation or 20% with indexation. Dividends from these funds are tax-free in the hands of the investors but would be subject to a dividend distribution tax of 25%.

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