Capital Protection Funds - Meaning, Features and Who Should Invest

Investment companies build opportunities by investing in professionally managed securities or assets to fulfil investors financial goals, such as income and capital growth. If the safety of capital is your agenda, then you should invest in capital protection funds. Read further to know more about the fund, its feature, and who should invest.

Getting started with Capital Protection Funds

For any investor, losing money is the biggest fear. Mutual fund sector capitalises on this fear by allowing them to invest in Capital Protection Fund. It safeguards your capital and offers returns, which is over and above the principal amount you invest.

When mutual funds are categorised based on the structure – they are either open-ended or closed-ended funds and these can either belong to equity, debt or hybrid asset class.

What is Capital protection fund?

Capital protection fund or Capital Protection Oriented Fund is a type of close-end hybrid fund that protects the capital gains of the investors during economic downturns, thus ensuring capital appreciation. The fund invests in a combination of fixed income instruments like treasury bills, bonds and certificate of deposits (CD) and the rest in equity. A major investment chunk is towards the debt component to get returns on the capital invested and equity offers growth opportunities.

Features of Capital Protection Fund:

  • The fund is a close-ended scheme that has the majority of investment in debt/money market instruments and the rest in equity and equity-related instruments

  • The tenure ranges from 1, 3 to 5 years & investors cannot redeem units before the maturity of the tenure

  • This is a low-risk scheme

  • The scheme is oriented towards protection of capital and does not assure guaranteed returns

Who should invest in Capital Protection Oriented Fund?

  • If you're an amateur investor or a first-time investor, you can invest in the hybrid fund.

  • Investors who prefer capital protection over capital appreciation

  • It is ideal for investors who have a long-term investment plan as maximum tenure is of 5 years

According to the Securities and Exchange Board of India, asset management companies (AMC) are not allowed to market the fund as "oriented towards protection of capital." The regulator mandates the AMCs to declare that there is "no guaranteed capital returns" if investors choose this fund.

How does the Capital Protection Fund work?

As mentioned earlier, the capital protection funds invest 80%-90% of assets in debt securities and the rest in equity instruments. The debt component of the fund ensures that investor gains the principal amount invested as returns post the maturity. On the other hand, the equity generates returns which are quite attractive as compared to fixed deposit returns. Let's understand this with an example:
  • Suppose you invest Rs.1000 in a capital protection fund.

  • The fund manage allocates 900.09 in debt securities that generate 10% interest earnings at the time of maturity

  • The interest earnings through debt funds will help to recover the principal amount

  • The remaining amount invested in equity instruments will generate higher returns over and above the principal amount

How to choose the Capital Protection Fund?

The selection of capital protection fund depends on your risk tolerance, liquidity needs and investment horizon. Follow the below steps to choose a suitable fund for you:
  • Step 1: First, make sure you know about your investment objective

  • Step 2: Check out the CRISIL rating for the scheme you wish to invest in

  • Step 3: Select the tenure as per your investment plan

  • Step 4: Make sure to read offer documents carefully to understand the balance of risk and return

  • Step 5: Asset allocation is most important to ensure returns from the fund

Taxation on capital protection funds

Since capital protection funds majorly invest in debt funds, the taxation is as per the debt funds. If you're redeeming the mutual fund units before three years, it will fall under Short-term Capital Gain (STCG), and hence the applicable tax rate would be as per the Income Tax slab. If you're holding the asset beyond three years, the returns will fall under Long-Term Capital Gain (LTCG), and thus the applicable tax rate would be 10% without indexation and 20% with indexation.