Do you want to protect capital?

Though capital-protection funds don't create much wealth, they could help limit wealth erosion

It's not easy to take a call on stock markets in these volatile times. No wonder, investors have been selling their equity mutual fund units with every rise in the Sensex. Fund houses, on their part, are trying to attract investors with either debt schemes or capital-protection schemes or dual-advantage funds. In the last two categories, 80 per cent of the money is invested in debt and 20 per cent in equity.

These schemes are expected to generate accrual income in a way that it may reach the initial investment value on maturity of the scheme. The remaining portion is invested in equity derivatives, such as call options.

In other words, you will get some equity benefit if the market goes up. If the market were to fall, the debt component will curtail your losses. In other words, such products promise to give the best of both worlds, especially if you are a risk-averse investor. But as Sumeet Vaid of Ffreedom Financial Planners, these types of funds are ideal for preserving capital during a market dip. But he is quick to add that it is quite difficult to create wealth with these schemes.

According to data from Value Research, over a one-year period capital protection funds have given returns of 8.31 per cent and dual advantage funds have given returns of 9.2 per cent.

"With the reduction in interest rates, dual advantage funds have given yield of around 9 to 9.5 per cent, which is certainly a better return when compared to fixed deposits," says Rashmi Roddam, Director - WealthRays Group. However, with the Employee Provident Fund giving as much as 8.5 per cent last financial year and gilt funds returning as much as 12.17 per cent, returns aren't a great parameter to go by. If one adds the inflation impact, the real returns would be negative as well.

The schemes are not very liquid either as many of these schemes have a lock-in period of three years, but don't provide any tax benefits (like equity linked savings schemes). They are treated as debt funds and taxed accordingly. This implies that the high networth individual (with tax bracket of 30 per cent) may stand to get some benefit from them as compared to a fixed deposit. If you are in the lower tax bracket, the benefits aren't substantial.

These schemes are seeing some traction in the past year because investors are unsure about markets and there has been a constant fear that interest rates would go down. Feroze Azeez, Director and Head Investment Products, Anand Rathi Private Wealth Management sums these products quite well with, ""Capital protection funds are low risk and low return instruments. Dual advantage funds are also low risk, but offer as much upside as index funds." According to him, these schemes could be important for your investment portfolio because of uncertain times. To get better returns from these products, use the direct investment option as it will help save on the expense ratio.