Capital Protection Funds Fixed Maturily Plans Good Investment
If safety of capital is your concern, you would probably think of parking your money in bank fixed deposits (FDs). Though, a smarter option would be to explore mutual fund debt schemes, which offer better tax-adjusted returns without taking too much risk.
In debt mutual funds, the least risky options are capital-protection funds and fixed-maturity plans or FMPs. Both are close-ended schemes where no redemption is allowed before maturity.
The main aim of a capital-protection fund is to protect the principal by investing a part of it in fixed-income instruments such as bonds, T-bills and certificates of deposits (CDs). The rest is invested in equities.
“The debt-equity allocation is based on the yield on bonds and the tenure of the scheme,” says Puneet Pal, head, fixed income, BNP Paribas Mutual Fund.
Imagine a fund of Rs 100 which invests in debt securities with 10 per cent yield. To protect its capital, it will invest Rs 90.909 in these securities so that this amount becomes Rs 100 (at 10 per cent yield) after a year. The rest, Rs 9.091, will be invested in equity or related instruments.
The value of the equity portion at the end of the tenure will be the gain. If it grows 15 per cent to Rs 10.45, the value of the investment at the end of the tenure will be Rs 110.45, a gain of 10.45 per cent. If the equity portion falls 15 per cent to Rs 7.73, the gain will be 7.73 per cent. “Investors must note that the capital protection offered is not guaranteed but only assured,” says Jiju Vidyadharan, director, Funds & Fixed Income Research, Crisil Research.
The Securities and Exchange Board of India has mandated rating of the fund structure by a credit rating agency for assessing the degree of certainty with which the objective of protecting capital can be met.
“The top rating for capital-protection funds is AAA, indicating the highest degree of certainty regarding timely payment of the principal on maturity,”
FMPs, on the other hand, generate FD-like returns by investing in bonds and holding them till maturity. Let’s assume an FMP that invests in a couple of one-year CDs trading at 9.5-9.7 per cent. Since it will hold the CDs till maturity, it can be expected to return 8.5-9 per cent to investors after deducting the expenses incurred. Since FMPs are passively-managed, their expense ratio is on the lower side (up to 1 per cent).
“People should not expect super-normal returns. In a good scenario, FMPs will return 1-2 per cent more than debt,” says Raghavendra Nath, managing director, Ladderup Wealth Management.