Capital protection oriented funds - Aimed for Safety with potential growth opportunities

Equity investments are attractive, especially when you see the market benchmarks S&P BSE Sensex or Nifty 50 soar or hear about success stories of stock pickings by investors. However, the reverse of that - downfall especially during the short term - is also true. Investors who do not have the risk appetite or understanding mostly tend to opt for pure debt-based investments. But what if we tell you that a risk-averse investor can invest in equities while limiting the downside risk? The mutual fund universe offers a solution in the form of capital protection oriented funds.

As the name suggests, the primary objective of capital protection oriented funds is to endeavor to safeguard capital invested. In other words, the downside risk is minimised, enabling investors to aim for decent returns even when equities perform poorly. When the equity market is buoyant, returns earned by the fund are enhanced owing to capital appreciation generated by the stock portfolio of the scheme. Capital Protection Oriented funds are closed ended funds and are “oriented towards protection of capital” and not “with guaranteed returns.” Further the orientation towards protection of capital originates from the portfolio structure of Capital Protection Oriented funds and not from any bank guarantee, insurance cover etc.

Read on to find out how.

How it works

To achieve the capital preservation objective, capital protection oriented funds invest majority of assets in fixed income instruments such as bonds, certificates of deposit, Treasury bills etc. The selection of securities that form the debt component aims that investors will, at a minimum, recover their initial investment at maturity. Moreover, the fund manager ensures that the maturity of securities in the debt portfolio is on or before the stated tenure of the scheme. Capital protection oriented funds may, thus, have maturities ranging from one year to five years. The return earned over and above the initial investment is a function of the funds allocated to equities and the return generated by equities, as illustrated below:

Consider an investment of Rs 500. The annual yield generated by debt securities at the time of investment is taken as 7.04% . Approximately Rs 467 is, thus, invested in the debt portfolio, which will enable the investor to recover the initial investment of Rs 500 at the end of the tenure of the scheme, which is assumed here as 1 year. The fund allocates the residual amount, approximately Rs 33 in this case, to equity securities at the time of investment.

Average returns of CRISIL-ranked liquid fund schemes as of year ended January 2019 (%) Assumed annual return of equity securities (%) Debt allocation (Rs) Equity allocation (Rs) Equity end amount (Rs) Total portfolio end amount (Rs) Portfolio CAGR (%)
7.04%-15%467.1232.8827.95527.955.59
7.04%-10%467.1232.8829.60529.605.92
7.04%-5%467.1232.8831.24531.246.25
7.04%5%467.1232.8834.53534.536.91
7.04%10%467.1232.8836.17536.177.23
7.04%15%467.1232.8837.82537.827.56

For illustration purpose only. The debt allocation is calculated assuming 7.04% returns on the debt allocation at the end of the tenure of the scheme. The calculation does not take into account any charges, management fees and any other expenses if any.

As can be seen, the investor earns a positive return of 5.92% at the end of the year even if sentiment for equities is bearish (negative 10% returns). When equities perform better, the portfolio’s return rises to 6.91% (when equities generate 5% growth) and 7.23% (when equities grow 10%).

Besides the downside-risk protection, other advantages of capital protection oriented funds include:


1 Average allocation of close-ended Capital Protection Oriented Funds to AAA-rated securities and Gilts, as per CRISIL classification in January 2019.

@As per current applicable tax laws, which are subject to change.

Summing up

Capital protection oriented funds are appropriate for investors who are risk-averse, but who would like some equity exposure to enhance the portfolio’s gains. During periods of high equity volatility, the debt component cushions the portfolio against downside risk. However, higher allocation to debt comes at the cost of increased upside potential when equities are in flavor. Investors must note that these funds are close-ended and, thus, their money gets locked in for the tenure of the scheme investment period except for some limited liquidity is available by selling it in the secondary market, as close ended schemes are listed on stock exchanges. Redemption of the close ended schemes is not allowed prior to the maturity of the scheme. As always, it is best to invest keeping in mind one’s objectives, investment horizon and risk-tolerance. Investors shall always refer to the Scheme Information Document and Key Information Memorandum of the Capital protection oriented funds carefully to understand the detailed risk factors and investment strategy associated with the scheme.

Disclaimer:

Any comparison mentioned in this material is for general information only and not intended to be relied upon as investment advice and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. Information and content herein has been provided by CRISIL Research, a Division of CRISIL Limited, and is to be read from an investment awareness and education perspective only. Recipient are advised to seek independent professional advice before making any investments. The views / content expressed herein do not constitute the opinions of SBI Mutual Fund or recommendation of any course of action to be followed by the reader. SBI Mutual Fund / SBI Funds Management Private Limited is not guaranteeing or promising or forecasting any returns.

In view of the individual nature of the financial or tax consequences, each investor is advised to consult his/her own financial/tax consultant with respect to specific tax implications arising out of their participation in investments. The tax rates are as per current tax laws and are subject to change.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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An investor education initiative, SBI MUTUAL FUND.