Invest in Capital Protection Funds if you are risk avorse Investor

Capital protection-oriented funds help conservative investors avoid undue risks and earn higher returns than traditional fixed-income products

Should you try to preserve your capital or should you resort to value investing to make money in the long term? Even as the markets are hovering around all-time high, many investors are pondering over the question these days as they see conflicting signals emerging from the mutual fund houses. For example, ICICI Prudential AMC and LIC Nomura AMC have recently opened their new fund offers (NFOs) of capital protection-oriented funds (CPOF) for subscription. Axis and Pramerica MFs are coming out with schemes that would invest in shares of small and mid-sized companies. NFO of ICICI Prudential Value Fund closed recently after collecting . 645 crore. As you can see, one set of offerings look to preserve capital in anticipation of a market fall, whereas the other theme is trying to explore value investing. Markets may remain volatile in the short term. But it is time to allocate some money to equities with 3-5-year time-frame, given the attractive valuations of the broader market.

A Case for Capital Protection Funds

That settles the matter in favour of value investors. However, conservative investors who don't want to take any extra risk can still explore capital protection-oriented products. These schemes are primarily meant for conservative investors with 3-5 years' investment time-frame. Investors like investment avenues that provide higher returns than traditional fixed income products without taking any additional undue risk with their principal. CPOF offers investors the benefit of upside in equities in limited manner without any risk on capital, he adds.

If you find that argument convincing, you can check the universe of CPOFs. They are essentially closed-ended schemes that invest in a mix of equity and debt. They come with two-, three- and five-year tenures. In a five-year fund, around 75% of money is invested in good quality bonds that would ensure return of capital at the end of five years. The remaining 25% is invested in equities to boost returns. While we expect markets to remain volatile till the polls, equities definitely look a better asset class compared to real estate and gold. Valuation of equities is attractive, especially in the midcap space. Generally, we have seen equities provide healthy returns when bought during periods of low GDP growth and we feel we are close to the bottom in that respect.

Realistic Expectations

The funds promise the best of both — equities and debt — but experts advise a realistic approach. These funds can be considered to start allocating some capital to equities by conservative investors who have remained out of the markets for last few years, but the returns expectations must be realistic. Though most of the fund managers invest the equity component of these schemes in high conviction ideas that are expected to deliver over the tenure of the scheme, the returns cannot be exceptional given the small allocation to equities. Consider a situation: if the fund manager has invested 20% of the money in equities and it doubles over three years, the effective portfolio return at the end of the third year is in the range of 11-12%. Expect a bit more than AAA-rated three-year fixed deposit. Taxation is another issue with these schemes, which are taxed like a debt fund.

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