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| Recipe to make your own Capital Protection Plans |
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Since SEBI allowed capital protection plans, a few mutual funds such as Franklin Templeton, Birla Sunlife, and SBI have launched products that ensure the investor receives the capital invested on maturity. The schemes sound safe and at the same time aim at higher return than a bank deposit or other fixed income products.
Typically, such schemes have a lock-in period of 3 to 5 years. 3 years plan allocates up to 20% of their funds to equity related investment while the balance are invested in fixed income investments with the time horizon of almost 3 years. Similarly 5 years plan allocates up to 30% in equity and the balance in fixed income instruments with the maturity of 5 years.
Essentially the income from the fixed income investment hedges the investment made in equity. For example, if you invest Rs. 100 in a 3 year capital protection scheme, and the current rate of return on 3 years instrument is 8%, then that part of Rs. 100 will be invested in 3 years instrument that would mature at slightly over Rs. 100 there by ensuring capital protection i.e. if you invest Rs. 80 in such fixed income instruments, then after three year it will fetch you Rs. 100 on maturity. This leaves Rs. 20 to be invested in equity related instruments without any risk of capital erosion while any positive return will provide the upside.
While logically sound strategy, it actually works out to be too conservative. The returns from such strategy are limited. You can have your own assessment of risk appetite and time horizon and build your own portfolio with a right mix of equity and fixed income products.
If your goals are long term, being ultra-defensive barely takes you anywhere. Take a portfolio of Rs. 5 lakhs, 8% annualized return on debt investments and 25% on equity, and long-term capital gains tax of 11% for debt and nil for equity. A debt-only risk free portion grows to just Rs. 7.1 lakhs in 5 years. By comparison, a 70-30 debt-equity portfolio grows to Rs. 9.5 lakhs. And the risk odds are favourable – the equity portion has to depreciate 96% for you to start losing your capital. The table below projects returns and risk for different asset allocation.
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Scenario 1 (Debt/Equity 100/0) |
Scenario 2 (Debt/Equity 70/30) |
Scenario 3 (Debt/Equity 50/50) |
Scenario 4 (Debt/Equity 30/70) |
| Years |
Corpus Value |
%downturn to erode capital |
Corpus Value |
%downturn to erode capital |
Corpus Value |
%downturn to erode capital |
Corpus Value |
%downturn to erode capital |
| 3 |
614,585 |
N.A. |
723,178 |
-53.47% |
795,574 |
-22.92% |
867,969 |
-9.82% |
| 4 |
658,343 |
N.A. |
827,051 |
-73.89% |
939,523 |
-31.67% |
1,051,995 |
-13.57% |
| 5 |
705,217 |
N.A. |
951,416 |
-95.77% |
1,115,548 |
-41.04% |
1,279,680 |
-17.59% |
The bottom line is that risk and return go hand-in-hand. A bias in favour of one has a trade-off for another. The key is to know your time horizon, your appetite for risk and choose an asset allocation that suites your profile. Also, since you are doing it yourself, there is really no lock-in period and there can be opportunities along the way to balance your allocation to further fine tune the risk-reward equation. |
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