Smart ways to protect capital, ensure decent returns from equity investment

Use these smart strategies to ensure decent returns from equity investing

With global headwinds like US-Iran tensions and slowdown in the Indian economy, stock markets are likely to remain volatile for some more time, say experts. The NSE India Volatility Index or VIX on Tuesday rose to 15.64 – up 7.05 per cent. So, even if one is investing through equity mutual funds, one has to be careful and think of means to avoid loss of capital. This is especially true for conservative investors or ones close to retirement because while returns are important, capital protection should take prominence. There are a few strategies that can help achieve this:

Capital protection-oriented funds (CPOF): These are schemes with a fixed maturity – say three years. They invest in a mix of bonds and stocks in a way that the money invested in bonds gives back the capital and the money invested in stocks provides higher returns, or as they say, the alpha. “As debt instruments are held until maturity, the probability of mark-to-market losses due to interest rate fluctuations is mitigated. For investors who are spooked by the volatility of stock markets and yet do not want to lose out on the opportunity to make gains, investing in closed-end hybrid schemes such as CPOFs can be beneficial,” says Rajiv Bajaj, chairman & managing director, Bajaj Capital.

Akhil Chaturvedi, associate director and head of sales, Motilal Oswal Asset Management, says these funds can be a substitute for fixed deposits. “These funds are like defensives in the client’s portfolio and help him make predictable returns with low volatility over the investment tenor,” he says.  

Since they are closed-end products, investors have to forgo liquidity. Though their units are listed on the stock exchange, they rarely trade at fair value.

Dividend transfer plan (DTP): Invest your money in the dividend option of a liquid fund and sign up for DTP. Each time the liquid fund announces a dividend, the amount is transferred to the equity scheme you have chosen. Choose a multi-cap fund as the transferee scheme. “Investors who do not want to take equity market risks and are sensitive towards protecting their capital value can do so by parking a lumpsum amount in fixed-income funds. These funds ensure safety of capital, and returns from such funds can be systematically transferred to equity funds. This also leads to rupee-cost averaging and helps earn slightly better returns than pure fixed-income funds,” says Chaturvedi.

Remember that any dividend announced by a liquid or bond fund is subject to dividend distribution tax of around 29 per cent. Second, if the amount of dividend falls below a threshold, it is reinvested back in the scheme. 

Capital appreciation transfer plan: You can also use this tool to invest in equity mutual funds systematically. Here, you may choose to transfer on a monthly basis only the capital appreciation in your source scheme to a target scheme. Invest in a liquid fund or bond fund and instruct the fund house to transfer the capital appreciation every month. The rules pertaining to exit load, minimum investment amount and minimum incremental investment amount will apply. “This strategy is good for conservative investors who want to protect their principal and take a risk with only the returns. This could be a better option compared to the dividend transfer option. On the one hand, the probability of capital protection is higher while on the other, it is more tax-efficient,” says Bajaj.

Trigger facility: Investors can also use the trigger facility, which allows them to instruct the fund house to transact (buy,  sell or transfer) in the units held if the given condition is satisfied. For example, an investor can instruct the fund house to sell all the units of an equity mutual fund if the net asset value were to fall below a particular level. One can also instruct the fund house to transfer units of an equity mutual fund to a bond fund if capital appreciation of a particular size is seen. You can set the trigger in such a way that your capital is preserved, or a certain minimum capital appreciation along with capital is protected in case of a massive fall in the stock market.

However, be careful with the condition you specify when defining a trigger. The trigger should not get activated too early. You can register, modify or cancel the trigger anytime. But once the fund house acts on it, little can be done about it. Each transaction is subject to exit load and taxation. “Triggers are not meant for the average investor; they are more suited for the informed investor who knows how much she wants to earn, and is willing to take the risk of his/her view going wrong. For long-term equity investors, returns materialise over a period of time. There are good and bad years, and if you exit too soon in a bull market the long-term return from equities will suffer,” adds Bajaj.