Should i invest in Capital Protection Fund ?

There is a famous saying that Marketing rules the roost. Capital Protection Fund is one such example. The biggest fear of any investor is to lose money. Capital Protection Fund capitalize on this fear. Its like providing safety net to your principal aka Capital invested and delivering returns over and above the principal amount invested. In short, the fear of loss of basic capital/principal is eliminated…Sounds interesting!!! Some MF advisors project Balanced Funds as type of Capital Protection Fund but it is not correct. Balanced Funds are riskier as they are classified as Hybrid Funds – Equity Oriented. Equity exposure of a Balanced fund is more than 65%. Balanced funds can potentially return -ve returns despite 35%-40% exposure in debt. Capital Protection Funds are designed in such a way that even in worst case scenario average return will be 1%-2% but it will never be negative. Lets understand how

How Capital Protection Fund Work ?

It is not a rocket science but smart strategy to market product as Risk Free. If an investor invest Rs 100 in Capital Protection Fund then the Fund Manager will invest Rs 80 in debt instruments which will yield average 8% return (current scenario) over a period of time. After 3 years, Rs 80 will become Rs 100 @ 8% annual yield therefore prinicpal capital of Rs 100 is protected. Rest 20 Rs will be invested in Stock Market. In worst scenario if Stock Market collapse, Rs 20 will never become Zero. On +ve side assuming average return of 10% from stock market over 3 years (based on historical trend). Rs 20 will be approx Rs 26.6 after 3 years. In short, Rs 100 will become Rs 126.6 in 3 years time without any risk. Annual Return from Capital Protection Fund will be 8.18% in this case. In worst case scenario, if stock market collapse by average 30% in 3 years then also Rs 20 will be Rs 6.8 after 3 years therefore average return of 2.2% from capital protection fund. On other hand, Capital Protection Fund will beat returns of debt funds if Stock Market return average 30% during 3 years. Return from Capital Protection Fund in this case will be 13%. As Capital Proetection Fund invest fraction of asset in equity therefore it will never give negative returns.

Should i Invest in Capital Protection Fund or not

Before you decide to invest in capital protection fund, please go through following points.

(a) Capital Protection Funds are closed ended funds. Fund Manager has leverage to invest in long term instruments and redemption pressure is not much. You need minimum 3 years horizon to protect your capital. Untill unless fund house has huge assets under capital protection fund, 20% capital is not sufficient to play around in stock market. In short, equity portion will not be actively managed by the Fund Manager.

(b) Very limited potential to provide high returns. In best case scenario, Returns from Capital Protection Funds will be 12%-13% provided stock market yield 30% annual return.

(c) Taxation: Capital Protection Funds are classifed as Debt funds therefore any redemption before 3 years will be treated as Short Term Capital Gain i.e. will be taxed as per IT slab. After 3 years, indexed gains will be taxed at 20%.

(d) Objective of Investment: The investment objective of capital protection fund is not very clear. If objective is only to protect capital then we have debt funds which can also be classified as Capital Protection funds. Only objective which i foresee is to beat the returns of debt funds by deploying small amount in equity market

Create your own Capital Protection Fund

If your sole investment objective is to beat the returns of debt funds with safety net on principal investment then you can create your own Capital Protection fund. Just follow 2 simple steps

(a) Invest 80% amount in Debt Funds. Within debt funds invest equal amount in Income Funds, Short Term Funds and Liquid Funds to hedge risk against interest rate movement.

(b) Balance 20% can be invested in good diversified equity fund which is consistent performer and actively managed.

Capital Protection Fund is good option if you are not an active investor. It is advisable to create your own capital protection fund with flexibility to select some good debt instruments in your portfolio.

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Happy & Profitable Investing !!!

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