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Capital Protection Oriented fund

Money managers and investment advisers often come across existing and prospective investors who, rather than willing to take some risk, are more focused on protecting their hard-earned money - the funds they already have. If they have Rs 100 to invest for three or five years, such investors are more interested in getting the principal back. They don't like to take a chance to grow the principal to Rs 150 or Rs 160 or even more with the probability that the Rs 100, in case the market scenario turns bad, may even become Rs 90 or Rs 80 or even less.

For investors like these, money managers have come out with a new type of fund -- the capital protection oriented (CPO) fund. These are a special category of closed-ended schemes which guarantee that the Rs 100 that every investor puts in will always be returned to them. In addition, there is also a chance to get back some additional returns.

There are several structures of CPO funds but the basic premise is more or less the same. Here, part of the Rs 100 is invested in risk-free assets giving a rate of interest that in a compounded basis will bring the initial investment back to Rs 100 at the end of the tenure of the fund. For example, if a CPO fund is for five years and the current risk-free rate of return is 10%, about Rs 62.25 will be invested in those risk-free assets. The balance amount of about Rs 37.75 will be invested in equities which in five years have the probability to grow at a much faster rate than the 10% per annum that the Rs 62.25 earns. In the worst case scenario, this Rs 37.75 becomes zero; so at the end of the term the investor will still get back Rs 100 since at 10% per annum compounded rate, Rs 62.25 will become Rs 100 after five years.

Similarly, in a three-year CPO scheme with a 10% risk-free return, about Rs 75.25 will be invested in the risk free asset and the balance Rs 24.75 in equities. Since the chances of the value of equity portfolio turning zero is almost zero, historical data show that at the end of term of the CPO scheme, investors are always in the money. These are the funds where the debt part would give the stability to your money while the equity part would bring in the kicker. If you want some certainty of return from your investments, then this is the fund, although the returns are rarely very high. The returns from CPO funds could be described as bank FD-plus or FMP (fixed maturity plan) plus, which is mainly because of the equity component. These funds more or less compete with bank FDs.

CPO schemes, like all debt funds, incur a tax on the capital gains they generate. However, since the tenure is usually three years or more, long-term capital gains are taxed at 20% with indexation (adjusting the purchase price for inflation), said a financial adviser. If inflation has been high over the tenure of the fund, you may find yourself paying next to nothing in taxes. This is a huge advantage compared to fixed deposits, where interest is taxed according to your marginal rate of tax irrespective of the tenure of investment. The post-tax returns on debt funds can, hence, be higher, which give them an edge over fixed deposits

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