Many investors may aim for both capital protection as well as the participation in the equity markets. But, is it possible? May be, Yes, with the Capital protection oriented schemes (CPOS), which aim at principal protection at the same time offer an opportunity to participate in the equity markets and provide capital appreciation.
However, it is important to note that there are no guaranteed returns or guaranteed capital protection as such. Read more to learn more.
How does it work?
A part of the investment would be invested in debt instruments maturing on or before tenure of the scheme, this portion provides initial investment protection. Remaining is invested in Equity or any other instruments as per the objective of the scheme, this portion of investment provides capital appreciation.
Debt or Fixed income instruments include Bonds, T-bills and certificates of deposits (CDs). Debt – Equity proportion is determined by yield on the bonds and the tenure of the scheme.
Let’s look at an example:
Imagine a 5 year tenure fund of Rs 100 which invests in AAA rated fixed income securities with 8 % yield. To protect its capital, it should invest Rs 68.058 in these securities so that this amount becomes Rs 100 (at 8% yield) after 5 years. Remaining fund i.e Rs 31.94, will be invested in equity or related instruments. The value of the equity portion at the end of the tenure will be the gain.
Scenario 1: Equity markets appreciate:
If equity investment grows at CAGR of 12 % to Rs 56.28, the value of the investment at the end of the tenure will be Rs100 from fixed instrument plus Rs56.28 from equity portion, so total fund value at end of fifth year would be Rs 156.28. Initial fund value is Rs100 with a gain of Rs 56.28 or absolute return of 56.28% or annualized return of 9.34 %.
Scenario 2: Equity markets fall:
If the equity portion falls by 50% to Rs 15.97 by end of the tenure, then the total fund value would Rs100 from fixed instrument and the remaining equity portion Rs15.97, total fund value would be Rs 115.97 or absolute return of 15.97% or annualized return of 3%.
In both the cases, irrespective of the equity markets direction, investment in debt instruments ensures capital protection.
What is the Risk?
In the capital protection oriented schemes, there is no assurance that the investment objective of the scheme will be realized and the scheme does not assure or guarantee any returns. The scheme is oriented towards protection of the capital and not with guaranteed returns like fixed deposit. Capital protection originates from the portfolio structure of the scheme and not from any bank guarantee, insurance cover etc.
The SEBI has mandated rating of the fund by a credit rating agency for assessing the degree of certainty with which the objective of protecting capital can be met.
Who should invest?
It is general belief that investors who are risk averse and want to protect their capital against the downside risk and also want to participate in the equity market or any other asset classes may choose it as an option.
The capital protection-oriented schemes are close-ended schemes with a lock in period of one, three and five years. Investors with a long-term perspective may look at this as an option. CPOS are Hybrid–Debt oriented schemes and indexation benefit can be used for taxation.
Even though this can be a good investment option, it may not suit every investor as the suitability in investment products depends on one’s goals, tenure and risk appetite. Hence one should seek a professional adviser to understand the suitability of these investment products.