Most individuals' primary concern when investing in mutual funds is capital protection. Capital protection funds offer the dual benefit of capital protection and the potential to earn higher returns. However, these funds do not offer guaranteed returns. This article talks about the various aspects of capital protection funds, including what are capital protection funds, how they work, features, benefits, etc.
What is a Capital Protection Fund?
These are close-ended hybrid mutual funds that are oriented towards protecting your capital from any type of market risk by balancing the exposure to both debt and equity. Such a fund is known as a capital protection fund. The portfolio of such funds largely focuses on debt funds and invests in debt instruments like t-bills, highly rated bonds, certificates of deposits, and other fixed-income securities that ensure capital protection along with assured maturity returns.
The primary objective of these funds is to reduce the impact of economic downturns by focusing on fixed-income securities and debt instruments. This strategy aims to protect investors' capital while potentially yielding annual appreciation on their investment.
How do Capital Protection Funds Work?
Investors' funds are divided between equities and debt securities. Approximately 80-90% of the assets are placed in debt, while the remaining portion is directed towards equities. The allocation in debt ensures that investors can reclaim their initial investment when the investment matures. Meanwhile, the investment in equities aims to generate higher returns compared to those typically offered by Bank Fixed Deposits.
For example, if an investor puts ₹1000 into a capital protection fund, the fund manager will allocate ₹900.09 into a debt instrument yielding 10% interest at maturity. This allocation guarantees the recovery of the principal investment over the scheme's duration. The remaining amount is invested in equity instruments to potentially boost returns and thereby enhance the investment's value.
What are the Benefits of Capital Protection Fund?
Capital protection funds offer various benefits. Given below are some of them -
Balanced Portfolio - These funds provide a balanced portfolio that combines fixed-income securities like zero coupon bonds and equity investments. This creates a balance and allows investors to enjoy the stability offered by debt funds along with the handsome gains form equity markets.
Capital Protection - Investing in capital protection funds is a great choice for risk-averse individuals who want to protect their capital while gaining the benefits of equity funds. These funds help balance the debt-equity ratio by allocating 80% of the funds to highly-rated debt funds and the rest to equity funds. If the equity investments perform well, the investors can experience substantial growth in their portfolios.
What are the features of Capital Protection Funds?
Below mentioned are the special characteristics of capital protection funds -
Close-ended Scheme: Capital protection funds can only be subscribed to during the NFO period since they are close-ended. The capital protection fund managers invest the amount of money pooled in the securities that generate long-term returns. Since these are close-ended funds, they are not highly liquid in nature. However, these funds can be traded in the secondary market by the unit holders.
Lock-in Period: The capital protection funds have three different lock-in periods: one year, three years, and five years. Once the subscription is made, the investors must wait until maturity to redeem these funds. Therefore, these funds are suitable only for those investors who can lock in their money for the specified period of time and don’t need the invested amount for that time period.
Taxation Policy: The tax treatment of capital protection funds is similar to debt funds. If the maturity period is 1 year or 3 years, then short term capital gains tax is applicable to capital gains as per the tax slab of the investor. And for funds having a maturity period of more than 3 years, long-term capital gains tax is applicable.
Who Should Invest in Capital Protection Funds?
The choice of investing in capital protection funds or not depends on his/her risk preferences and financial goals. You should consider investing in capital protection funds in the following cases -
Risk-averse - If you are a risk-averse investor and want to protect your capital from market fluctuations, then capital protection funds are the ideal choice for you. These funds offer capital protection as most of the portfolio consists of debt funds.
Benefits of both debt and equity funds - These funds provide the benefits of both debt funds, i.e., stability and fixed returns, as well as the potential of equity funds for earning higher returns.
Investment horizon - The capital protection funds come with a tenure of 1 year, 3 years, and 5 years. If your investment tenure aligns with the tenure of the fund, you can choose to invest in it.
Capital protection funds are the ideal choice for those who can lock in their funds for a period of one year, three years, or five years and want to get the benefit of both capital protection and capital appreciation. Capital protection funds for 5 years also offer tax-saving opportunities as its returns are taxed at a concessional rate.
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