These funds invest a minimum in equities, but even this is enough to drag down the fund in a downslide

Canara Robeco Mutual Fund has filed an offer document with the Securities and Exchange Board of India (SEBI) to launch a closed-ended Capital Protection Oriented Fund. It will be called Canara Suraksha Fund-Series 1. Capital protection funds are structured products, designed to attract risk-averse investors to the stock market.

The scheme endeavours to protect capital by investing in high-quality fixed income securities maturing in line with the scheme's tenure as the primary objective, and to generate capital appreciation by investing in equity and equity-related instruments as a secondary objective.

The scheme offers both growth and dividend (payout) options for investment. Its two-year plan invests 85%-100% in debt securities and money market instruments where there is low to medium risk. The three-year plan will do the same, except that asset allocation will be 75% -100%, and the one-and-a-half-year plan investment will invest 80%-100% in these instruments. The two-year plan will invest up to 15% in equities, the three-year plan up to 25% and the one-and-a-half year plan will invest up to 20% in equities.

Capital protection funds invest most of their capital in assets with a low risk, for example in government securities. At the end of maturity, this part of the capital with its returns will be worth as much as the capital of the fund at inception. So the invested money can be repaid to investors at the end of the investment term. The remaining smaller part of the capital is to be invested in more risky assets. The possible yield on this part could produce the extra return over the capital protection at the end of the duration. The funds do not invest directly in bonds or equities, but in complex structured assets, usually options.

But how useful are these funds? Capital protection funds are advantageous for investors who do not want to expose themselves too much to equity risks, and they are willing to sacrifice some part of the returns to invest in safer instruments. With capital protection funds, you may also be exposed to exotic investments. For example: Far-Eastern or commodity market investments, which are undesirable and unsafe.

Apart from this, the high fee structure is a deterrent. The typical fee structure is 2.25% of assets under management. These funds invest mostly in risk-free instruments, which can be done by an individual without the expertise of a fund manager. The returns are also slightly higher than fixed deposits. They simply offer investors moderate safety and moderate returns. That is why they are benchmarked against the Crisil MIP Blended Index. There is little scope for fund managers' expertise and the high fees are not justified.

Most importantly, you cannot be sure that your capital will be protected, given the way the asset allocation will happen. If interest rates shoot up and equities fall sharply you could lose the capital. During the collapse of 2008, for instance, these funds should have protected investors from the downslide. However, this was not so. They underperformed miserably against their benchmarks in that year, yielding pathetic returns of -8% on an average. So, it can be seen that even with a minimal exposure to equities, such investments drag down the returns for the whole fund.