Past returns lower than MIPs, but these funds provide an opportunity to lock in at higher rates.
One of the biggest concerns for those investing in the equity markets is the erosion of their capital each time the market slumps. Fund houses have launched capital protection funds (CPFs) that supposedly address this. The past three months have seen as many as 10 such funds being launched. They haven't created a buzz among financial advisors. Should you invest in these?
CPFs are closed-end schemes, where around 80 per cent is invested in fixed income securities whose maturity matches with that of the scheme's. The other 20 per cent is invested in equities to generate the alpha for the fund in a bullish market and give downside protection in a bearish market.
| HOW CPF HAS FARED #Data as on - 21-Sep-2011 | |||
| Scheme Type |
CAGR | ||
Oriented Funds
*Active CPOs and Redeemed clubbed together
# Date applicable to MIPs and active CPOs not the redeemed ones
- In CPFs, 80 per cent is invested in fixed income securities and the rest is invested in equities to generate alpha for the fund
- AAA-rated corporate papers CPFs invest in are offering high yields of 9.5-10 per cent.
- Investing in a CPF now will be locking in for these high rates for three-five years, before these start moving downwards in the next six to nine months
LOCK AT HIGHER RATES
According to Amar Pandit, director of My Financial Advisor, there are reasons why so many CPFs are being launched. "The AAA-rated corporate papers that CPFs invest in are currently offering high yields of 9.5-10 per cent. Anyone investing in a CPF now will be locking in for these high rates for three-five years, before these start moving downwards in the next six to nine months," he says. Besides, the low equity markets are a good entry point and will see the equity component of the fund move up substantially in a rising market.
CPFs are an option for the conservative investor with an investment horizon similar to that of the fund and isn't interested in actively managing his portfolio. A hands-on kind of investor could modify the debt to equity ratio a little to work out his own capital protection strategy. Says Rajesh Krishnamoorthy, managing director of an online portal tracking mutual funds, iFAST Financial: "Say you have Rs 1 lakh and a two-year time frame. Low-risk products like liquid funds or an ultra short term fund will give you average two-year CAGR (compunded annual growth) returns of around five per cent. If you invest Rs 91,000 in these funds, it would recover the Rs 1 lakh in two years. The other Rs 9,000 could be invested in a diversified equity fund for the kicker in the overall returns."
PAST RETURNS
Returns from one of the top performing funds, Sundaram Mutual's Sundaram CPO-3 yrs (G), was 8.9 0 per cent. Post tax, this works out to eight per cent. As a category, three-year CAGR returns have been 8.12 per cent. In fact, these returns were lower than the three-year CAGR returns of 8.25 per cent given by monthly income plans (MIPs). Like CPFs, MIPs also invest in both debt and equity. "Being open-end schemes, MIPs are more actively managed. They generate higher alpha for the investor," says Gajendra Kothari, CEO, Etica Wealth Management firm.
CPFs have to be listed at the exchange and in the absence of a secondary market, may have to be sold at a discount. On the other hand, one can easily exit an MIP, subject to an exit load of one per cent in the first year.
TAXES
Both funds are subject to the taxes applicable to debt funds. That would be 10 per cent without indexation or 20 per cent with indexation on capital gains. Those in the highest tax bracket will benefit. Also, dividends from an MIP are tax-free in the hands of investors.
VARIATIONS
Among the new launches, Birla Sun Le Capital Protection Oriented Fund offers a variation, option-inked equity investments. But,these will only work well in a rising market,says Kothari. "In a rising equity market, the advantage of leverage that these funds will have, by way of buying the call option, will help these funds to pass on 70- 80 per cent of the Nifty's returns."
However, in a flat or negative market, the equity portion will not generate any returns, as the whole option will remain unexercised and expire accordingly. The buyer of the call option would lose the premium paid. In such circumstances, plain CPFs work better.
Plain CPFs are also said to be a first step for those who have just begun investing in mutual funds. The advice for those already investing is to stay away from funds set aside for long-term money into CPFs. Hemant Rustagi, CEO, Wiseinvest Advisors says, "Even if one is interested in investing in CPFs, one should at best invest 40 per cent of one's existing debt portfolio."
