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Capital in a cozy cocoon ?
This is exactly what you wanted - mutual fund schemes that target the need for safety of initial investment that has so far kept conservative investors out of the mutual fund ambit and to provide returns attractive enough to lure them away from guaranteed return products. On the face of it, capital protection schemes of mutual funds look inviting. But should you accept the invitation? Capital Protection funds are essentially a simplified version of structured products targeted at risk averse individuals. Investments are made in high quality debt, which typically commands lower yields. But by investing in such securities where the return of capital on maturity is more or less assured, fund managers are able to take a small exposure to a more risky asset, equity. Structured products are already highly popular in Europe. They are beginning to make their mark in India with a deluge of funds from reputed fund houses like Franklin Templeton, UTI, Deutsche, DBS Cholamandalam, Prudential ICICI …
Guarded guidelines In August 2006, market regulator Securities and Exchange Board of India (SEBI) issued guidelines permitting fund houses to launch "capital protection-oriented" schemes. SEBI said capital protection should arise from the way in which the portfolio is constructed and not from any guarantee by the asset management company or sponsor. It also required that the scheme be rated by a credit rating agency on the ability of the fund to protect the initial investment. The rating had to be reviewed on a quarterly basis and AMCs must ensure that the debt component of the portfolio had the highest investment grade rating (AAA or P1+). In addition, these schemes should be closed-end, so investors could invest only at the time of the new fund offer and could redeem only on the completion of its term or if it gets listed. I would like to draw your attention to the fact that the guidelines talk about an effort to protect capital. There is no mention about the effort actually having to succeed! How do these funds provide capital protection… A portion of the fund is invested in debt instruments that will mature at the value of the initial investment at the time of redemption. For example, out of Rs 100, Rs 80 may be invested in quality AAA-rated debt securities, whose maturity value is Rs 100. This way your capital is intact. The remaining Rs 20 is invested in equity, which tends to be volatile in the short term. Over a three to five-year period (which is the tenure of such funds), however, it is reasonable to expect a modest return from equity. Even if equity returns nothing, you still have your capital intact. …and have an edge? This is something that you can easily replicate by parking the funds in, let us say, a post office monthly income scheme (POMIS) and investing the monthly interest in the equity market. However, the advantage that fund houses bring is the use of sophisticated tools to apportion and manage funds between less risky assets and risky assets. The protection is at risk only if the value of the portfolio falls below the floor, Rs 80, and this is monitored on a continuous basis with built-in triggers. This ensures that you are able to reap maximum possible benefits by participating in an asset class that gives better returns without compromising on the safety of the capital invested. Edged out… Capital protection funds are excellent tools for fund houses because they are able to tap into a source of funds that has so far been cornered by bank deposits or post office schemes. However, you need to keep in mind certain issues before being carried away by the capital protection bait. These are: No Guarantee. No AMC or sponsor can guarantee against capital erosion. A high debt component means typical debt investment risks related to interest rate, default and reinvestment. More importantly, these schemes aim to protect your rupee investment and inflation is ignored. This means that even if you get the Rs 100 that you had invested, effectively you have lost money. Does this mean that you will lose money? Not likely. The closed-end nature of these schemes gives the fund manager the defined period benefit for making investments in debt instruments which ensure protection. Low liquidity. Being closed-end funds, you cannot exit during the life of the scheme for any reason, be it need for liquidity or poor performance by the scheme. Be on your guard Caveat Emptor is a policy that will always hold you in good stead. Chasing vague guarantee-like promises will land you in deep trouble. Capital Protection funds will not actually lose money but they will not earn much either. A modest return slightly more than an FD without risk is a pretty good deal. However, if you are somehow led to believe that these funds will reach up to the stars along with the index during bull runs and then miraculously not fall when the markets nosedive, then you are in for a rude shock. In real life, these funds will rise gently when the market shoots up and will go down less than they went up earlier when the markets reach their nadir. Capital-protection-oriented funds are predominantly debt funds that have a limited exposure to equity and, therefore, the returns cannot be compared to that of an equity fund. These funds are ideal vehicles for conservative investors waiting to participate in equity markets without risking their capital. A cosy cocoon for the capital invested … But if you are an investor with a long-term perspective and not hung up on capital protection, you are better off investing in a well-managed diversified equity fund.
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n Mrs. Lalitha Muthu e-mail : lalitha_ppm@yahoo.com |
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Articles by Lalitha Muthu |
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Capital in a cozy cocoon ? |