Capital protection is much sought-after by investors whenever they make a mutual fund investment. Capital Protection Oriented Schemes (CPOS) or Capital Protection Mutual Funds are inclined towards capital protection but do not offer guaranteed returns. Capital protection is mainly through portfolio construction and not necessarily through any form of insurance cover or bank guarantee.
Here’s all that you need to know about capital protection mutual funds including how it works, key features, who should consider investing in these, etc. Here, we will keep alternating between the terms CPOS and Capital Protection mutual funds, both of which have the same meaning.
Understanding Capital Protection oriented schemes
CPOS is close-ended hybrid funds in which the majority or about 80% of the corpus is allocated to investments in debt and money market instruments. The remaining funds are invested in equity and equity-related instruments. Some of the equity-related instruments include convertible debentures, warrants carrying the right to obtain equity shares, convertible preference shares, equity derivatives, etc. CPOS normally have tenures ranging between 3-5 years.
As per SEBI mandate, Capital Protection mutual funds must ensure that during the tenure of the fund, the debt component of the fund reaches the initial amount invested. This is a way of ensuring capital protection. These funds have to be mandatorily rated by a credit rating agency, and the investments made by the fund should be focused on instruments with the highest rating.
How do Capital Protection Mutual Funds work?
Capital Protection mutual funds collect funds from investors and allocate them in equities and debt securities. Through the allocation of a major part of the corpus in debt, the fund can ensure that the principal investment made by any investor is recovered at the time of maturity. On the other hand, the amount invested in equity instruments helps in generating returns that are generally higher than those that can be availed from Bank Fixed Deposits.
For example, if an investor invests Rs. 1,000 in a capital protection mutual fund, the fund manager allocates Rs. 900.09 in a debt instrument that offers 10% interest during maturity. This helps to recover the principal investment. The remaining amount is invested in equity instruments for higher returns and also to increase the value of the investment.
Salient features of Capital Protection Funds
Some of the noteworthy features of Capital Protection mutual funds are as mentioned below:
- Close-ended funds- Since these are closed-end funds, investors can subscribe to capital protection mutual funds only during the NFO period. Fund managers invest the pooled funds in securities that help to generate long-term returns. As these are closed-ended funds, investors cannot expect high liquidity of their funds invested in these schemes. However, the units of these funds are allowed to be traded in the secondary market by unit holders.
- Lock-in Period – Capital Protection Funds commonly offer 3 different maturity periods including 1-year, 3-year and 5-year. Investors can redeem their investment only after the maturity period is over. Thus, individuals who are comfortable to lock-in their money for the stated time horizons can consider investing in these funds.
- Tax – Capital Protection Funds attract the tax treatment as applicable to debt funds. In case the maturity period is 1 year or 3 years, Short Term Capital Gains Tax is applicable to capital gains as per the investor’s income tax slab. For a maturity period of more than 3 years, Long Term Capital Gains at 20% is applicable.
Who should invest in Capital Protection Mutual Funds?
Investors who wish to grow their investment with the least amount of risk should invest in capital protection mutual funds. Individuals with a conservative approach and low-risk appetite can safely invest in these funds. These are mainly designed for long-term capital appreciation combined with a sense of investment security.
It is important to note that returns from these funds are only assured, never guaranteed. SEBI has appointed credit rating agencies to calculate ratings for these funds and help investors in evaluating the reliability of the scheme to provide assured returns. This helps in assuring investors of capital protection to an extent.
What is the best time to invest in Capital Protection Mutual Funds?
Investors can consider CPOS investment in any of the following situations:
- During market volatility and medium-low inflation levels,
- Investment horizon is compatible with Capital protection mutual fund tenure
- When interest rate volatility is low
- When investors wish to invest in equities but want to avoid associated risks
- If an investor is aiming for tax efficient returns similar to fixed income deposits but with potentially higher returns.
While the market for CPOS may not be liquid, units of CPOS are usually listed for trading on the BSE and NSE.
Capital Protection mutual funds can benefit investors who have pre-defined financial goals and are comfortable locking their funds for a period of three to five years. However, investors should not expect guaranteed returns from these since the investment is subject to market conditions.
Frequently Asked Questions
What is a capital protection mutual fund?
Capital protection mutual funds invest in a combination of fixed income and equity instruments. These are closed-ended mutual funds that adopt a hybrid model focusing primarily on debt for better capital protection.
What is capital protection?
Capital protection, as in Capital Protection mutual funds, comes from the debt component that is managed in a way that the returns generated to come up to the level of initial capital invested. This assures investors that their initial capital investment is protected while being invested in such funds.
Are mutual funds protected?
Mutual funds, like any other investment in the stock market, are not protected against the risks like market and interest rate risks. Even if funds such as capital protection mutual funds come with the ‘protection’ element, these mainly protect an investor’s initial investment.
Which are some of the capital protection mutual funds in India?
Some of the capital protection mutual funds in India are:
- ICICI Prudential Capital Protection XI 2056 Days Plan A Direct Plan
- UTI Capital Protection Oriented Scheme Series VIII-II (1831 Days) – Direct Plan
- Sundaram Cap Protection 5 Years Series 8 Direct Growth
- UTI Capital Protection Oriented Scheme Series VIII-IV (1996 Days) – Direct Plan