Capital Protection Oriented Funds
Choosing between equity and debt is a difficult task for most investors.
To avoid this problem, one must invest on the basis of one's risk-return profile, age, investment tenure and market conditions. However, if you are among those who do not want the trouble of investing in a basket of products that needs to be rebalanced at regular intervals, you can opt for hybrid or Capital Protection-Oriented Funds (CPOFs).
Let us first understand what CPOFs and hybrid funds are...
How CPOFs work Investors are easily attracted to any investment avenue which has "capital protection" as it indicates safety.
However, this should not be confused with "capital guarantee". The best way to understand CPOFs is through an example. Let's say a CPOF is floated for a three-year period and 80% of the funds are locked in a three-year debt instrument. So, for every Rs 100 invested, Rs 80 would earn a simple interest of say 9% per annum. Accordingly that Rs 80 would become Rs 101.60 in three years. The balance Rs 20 would be invested in equity .
Now, even if the value of this Rs 20 drops by 25% and becomes Rs 15 at the end of three years, the total investment of Rs 100 would have become Rs 116.60. This translates into a simple annual return of 5.53%. So your own money is used to protect your capital. These are nothing but hybrid schemes which create a sense of security for investors who do not like to see volatility in their returns during the period of investment.
Suitability: It is suitable for investors who generally have a low risk appetite and are also comfortable with the lock-in tenure.
Taxation: These funds are taxed as debt funds, that is long-term capital gains tax applicable to these funds is 10% without indexation or 20% with indexation, whichever is less. Short-term capital gains do not arise as these funds are typically closed ended for three-five years.
Hybrids: Mixed asset allocation Hybrid funds, as the name suggests, have a mixed asset allocation pattern, typically investing in some amount of debt and equity . Lately, a few funds have also started adding gold as an asset class.
Hybrid funds can be typically put into two categories, that is `Equity-oriented' and `Debt-oriented'. Due to the inherent nature of taxation laws, most equity-oriented funds tend to have an exposure of 65-70% towards equity and the balance towards debt. As regards debt-oriented funds, the exposure to debt is in the 65-95% range and the balance is allocated to equity .
Some fund houses targeting senior citizens have floated monthly income plans (MIPs) which are nothing but hybrid funds with debt components ranging between 80% and 95%, with the objective of declaring a monthly dividend so that the investor gets a regular cash flow every month. Where gold has been added as an asset class, the allocation is typically 33% towards each asset class.
Suitability: These are suitable for investors who do not undertake an asset allocation exercise on their own, investors with low to medium risk appetite and investors looking at regular income.
Taxation: Equity-oriented funds (with more than 65% of the portfolio into equities) qualify for the same tax treatment as equity funds, that is short-term capital gains arising from redemption within one year are taxed at 15%, while there is no long-term capital gains tax.
Debt-oriented funds, those that predominantly invest in fixed income instruments, are taxed like debt mutual funds, where short-term capital gains are taxed according to the investor's tax slab while long-term capital gains are taxed at 10%, without indexation and 20% with indexation, whichever is less.
As far as the dividend option is concerned, dividend distribution tax (DDT) is charged at 28.33%, inclusive of surcharge and education cess for debt-oriented funds.
Thus an investor would have to factor this in before deciding which option to choose -growth or dividend.
For further information contact Prajna Capital on 94 8300 8300 by leaving a missed call
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