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If you are worried about losing money due to volatility in the equity markets, should you consider capital protection funds? These are closed-end funds that invest a major portion of their portfolios in debt and a small portion in equity. They seek to protect your money, while giving some capital appreciation.
According to Sunil Subramaniam, chief executive officer (CEO) of Sundaram Mutual, which has applied for a new, series of its existing fund, these are hybrid funds suitable for first-time investors investing in equities. They give a small allocation to equity while seeking to protect capital through a high quality debt allocation. “Hence, for a person who wants to gain experience in equity investing, these are ideal funds to start with, especially in these volatile times.”
Typically, capital protection funds start with 80 per cent investment in debt and in three years (usually they are closed-end funds of three years) move to 100 per cent debt. Hence, they might be suitable for investors who find it difficult to invest separately in equity funds on their own, says Hemant Rustagi, CEO of Wiseinvest Advisors. “Through these funds, investors can invest 20-25 per cent of their portfolio in equity without fear of losing capital,” he says.
Birla Sun Life, too, has applied for a new series of its existing fund and Kotak Mutual launched a capital protection fund last week. According to data from Value Research, one-year returns from capital protection funds range from -4.29 per cent to 9.58 per cent, in the case of regular plans. Some of the large capital protection funds in terms of assets under management are HDFC Capital Protection Fund - Series I (Rs 462 crore), Axis Capital Protection Fund - Series 5 (Rs 337 crore) and UTI Capital Protection Scheme-Series 4 (Rs 274 crore).
Since capital protection funds invest a large portion in debts and are closed-ended, the risk of capital loss is dramatically minimised. If equity markets do well in the given time-frame, investors can enjoy 'bank deposit plus' returns, says Subramaniam.
But the flipside is that returns are capped, since the objective of these funds is to avoid loss, says Vidya Bala, head of mutual fund research at Fundsindia.com. The lock-in period, too, is a disadvantage, as investors cannot get out even if they get capital appreciation unlike in open-ended funds.
“Today, investors can choose from open-ended debt funds like income funds or dynamic bond funds. These will not only offer capital appreciation on account of falling interest rates but also allow investors the opportunity to exit, which capital protection funds do not,” she says.
Subramaniam also agrees that if equity markets are significantly down at the time of maturity, then investors might get lesser returns than a equivalent tenor bank deposit.
Income funds actively manage the debt component, while capital protection funds manage the debt component on a 'buy and hold' basis. “In active management, there are benefits and/or disadvantage of 'interest rate risk', which can either give a capital gain or capital loss. In passive management, you are generally insulated from 'interest rate risk' and are able to benefit from the yield to maturity of the relevant debt instrument,” says Subramaniam.
In fact, Bala advises investing in pure equity funds through systematic investment to take advantage of rupee cost averaging in volatile markets.
