Capital Protection Funds: Worth it?

There are a number of New Fund Offers out there, for Capital Protection Funds, which means you invest some money today and they kinda-sorta guarantee that you will get at least the amount you invest. Typical fund structure, let’s look at the Sundaram Capital Protection Oriented Fund, Series 2: Type: Closed Ended, means if you buy now you can’t buy more of this later, and you have to stay on for the full term. Term: Three years. Concept: 80%-100% debt, rest equity or fixed-income derivatives. Liquidity: They won’t let you exit early by selling back to them, but will list on stock exchanges. So how do they do it? Guarantee capital, that is. Simple. You can’t get out before three years. If they invest in a three year “safe” instrument, like government securities, they are safe. But how much do they invest? Let’s see the current 3 year government bond – the yield is around 7.13%, but let’s just say 7%. Then deduct fund management fees of about 2.25% per year. They only need to invest Rs. 87 for every Rs. 100 they get at the NFO, so that the capital is protected – i.e. after three years, their Rs. 87 will grow to Rs. 100. The remaining Rs. 13, they can invest in equity, in fixed-income derivatives (Interest Rate Swaps, FRAs) or other such instruments. This provides a “kicker” – even if they lose it all, your capital is protected. What’s the problem? The 2.25% per year as fees. You are paying 6.75% to a fund that doesn’t need to do much – in fact, with the 87-13 structure, it is possible to construct a portfolio that both secures capital and gives you about 1x Nifty returns (i.e. if the Nifty returned 10% in the three years, the product will return 10%, but on the downside it loses nothing). This is simply through a "Structured Product” concept I’d spoken about earlier – and without the 2.25% a year as “fees”, you can earn substantially higher returns. And the liquidity? Is a joke. Of the few cap protected funds that are listed (search this list for “cap” and check quotes) I couldn’t find any that actually traded. So assume you’ll be in for three years. Conclusion: I don’t think this kind of fund or product is worth investing in. Simply buy short term funds for capital security with 80% of the money, and put the rest in something you can take risk on – like an index fund. Or, invest in a Monthly Income Plan (MIP) that offers similar structures. They may not guarantee returns but will take less than 2.25% every year (Good MIPs take 1.5%) and allow you to enter and exit at anytime. Sure, most MIPs come with an exit load if you leave within a year, but these cap protection funds lock your money for three years. I don’t like to write posts that say “don’t bother”; but I have been getting too many of these “Invest in a Capital Protection NFO” emails lately and reader questions about them, so I needed to clarify my thoughts.