Capital Protection Mutual Funds
Asset management companies offer various types of mutual fund schemes to help individuals fulfil their financial goals. Based on the investment objective, such schemes are segregated into different categories. One of them is a capital protection fund. Scroll through to know the meaning of these mutual fund schemes and all other related aspects.
What Is a Capital Protection Fund?
A capital protection fund is a closed-end hybrid fund. This fund’s primary objective is safeguarding an investor’s capital during market downturns. Simultaneously, it offers them scope for capital appreciation by participating in upturns of the stock market.
This fund invests in a mixture of fixed income instruments such as bonds, certificate of deposits (CDs), treasury bills, as well as equity instruments. In other words, the majority of the fund corpus is invested in fixed income securities for earning stable returns on the invested capital. Besides this, a small portion of the portfolio has investments towards equity to take advantage of the growth advantages, and provide capital appreciation.
How Does a Capital Protection Fund in India Work?
Capital protection funds usually allocate at least 70% of the fund corpus to debt instruments. The remaining capital gets invested in equity securities.
The amount allocated to debt securities ensures that an investor’s principal investment is recovered at maturity. Accordingly, these funds invest in debt securities with the highest rating. Furthermore, since these schemes hold the debt instruments till the end of the maturity period, interest rate risk is mitigated.
On the other hand, fund managers of these schemes invest the rest of the fund corpus in equity and equity-related instruments with purposes of achieving capital appreciation.
Consider the following example to understand the working of capital protection fund –
Investment in debt instruments
Investment in equity
CAGR on equity investment
Value of debt securities upon maturity
Value of equity portion upon maturity
Value of the fund at the end of the maturity period
Benefits of Capital Protection Funds
Here are the advantages of investing in a capital protection fund:
- Investors can reap the benefits of a market upturn without risking their initial investment amount.
- These funds invest in the highest rated debt securities. Accordingly, these funds are associated with extremely low credit risk.
- Since these funds allocate the pooled funds primarily to fixed income securities, they are able to provide stability to investors.
What Are the Returns from Capital Protection Funds?
Investors should keep in mind that capital protection fund returns are not guaranteed as these investments are not entirely risk-free.
SEBI or Securities and Exchange Board of India has assigned credit rating agencies to provide ratings to the fund structure of capital protection funds. Additionally, it has also assigned them to evaluate a scheme’s reliability to deliver assured returns. All these have been done to ensure the protection of the invested capital.
As per SEBI, AMCs are not permitted to market this fund as "oriented towards protection of capital." Furthermore, the regulator mandates the asset management companies to declare "no guaranteed capital returns".
Who Should Invest in a Capital Protection Fund?
Capital protection oriented schemes are suitable for the following individuals:
- Investors seeking stable returns
- Individuals who have a low risk appetite
- Investors who wish to earn higher returns than savings and fixed deposits
- Individuals who prefer capital protection to capital appreciation
Unlike open-ended debt funds, capital protection funds come with a lock-in period. Individuals cannot exit the scheme before the end of the maturity period.
To sum it up, investors who fear the stock market volatility but are unwilling to lose out on chances of generating profits can consider investing in close-ended hybrid schemes like capital protection funds.
Novice or first-time investors seeking equity exposure can also consider investing in these funds.
How to Invest in Capital Protection Funds?
Investing in capital protection funds will depend on risk appetite, investment horizon and liquidity needs. We have mentioned the following steps to invest in such funds.
- First, identify your investment objective.
- Then, check the CRISIL rating for the scheme in which you wish to invest.
- Now, choose the investment plan tenure as per the goal.
- Select a direct or regular plan
- Choose the investment route (SIP/lump sum)
Please read all the scheme-related documents to understand the returns and risk involved, and take a note of asset allocation before investing.
Furthermore, make sure that you consider a few vital factors before allocating your funds. To know about these factors, read on!
Things to Consider Before Investing in Capital Protection Funds
Investors might want to take these aspects into account before investing in capital protection oriented mutual fund schemes.
1. Investment Objective
The financial goals of all individuals is not the same. While some may seek maximum capital appreciation, another might want to earn stable returns. Hence, before investing, it is crucial for investors to consider identify their financial goals and make sure that they are in line with the investment objective of the fund.
2. Expense Ratio
Expense ratio is a charge that fund houses levy on investors on a yearly basis. Asset management companies impose this fee to cover the costs incurred for running the fund. Such costs include various expenses, including distribution fees, administrative expenses, fees charged by fund managers, etc. This annual fee directly impacts the returns of investors. Hence it is crucial that they compare the expense ratio of different capital protection oriented schemes before opting for a scheme.
3. Investment Horizon
Investment time horizon refers to the duration for which an investor is willing to stay invested in a scheme. Similar to financial goals, the time period for which investors would like to hold the untis in a scheme will differ from one individual to another. Individuals must make sure that the investment time horizon is in accordance with their financial goals.
4. Risk Involved
Capital protection oriented schemes are low-risk investments as the funds primarily allocates the fund corpus to top rated debt instruments. Investors must ensure to assess their risk profile before allocating their savings. If individuals have a high risk-bearing ability, they may consider opting for funds that have higher equity exposure.
5. Past Returns
By checking the past returns of the fund, investors can get to know whether the fund has been successful in achieving the goals that it was set up to achieve. In other words, past performance of a scheme represents a fund’s consistency. That said, keep in mind that the past returns of the fund does not indicate how it will perform in the future.
Tax Implications of Top Capital Protection Funds
Capital protection mutual funds invest more than 65% of the fund corpus in debt instruments. Accordingly, such schemes are taxed as debt funds. If investors opt out of a scheme before 3 years, the gains earned are known as short term capital gains (STCG). These returns are taxed as per the income tax slab rate of the investor.
If investors sell their holdings in a capital protection fund post competition of 3 years from the purchase date, the returns are categorised as long term capital gains (LTCG). A flat tax rate of 20% is levied on the realised returns. But note that investors get indexation benefits in the case of LTCG.
The best capital protection fund offers even highly conservative investors earn stable income while taking advantage of the growth opportunities in the equity market. That said, before deciding whether to invest in these schemes, make sure to consider the advantages and disadvantages keeping in mind your financial goals.