Consider the domestic investment scenario – Indian stock markets have returned a single digit  average annualized return  since 2008 and the future course is unpredictable. Similar is the case with debt markets with high inflation and uncertain interest rate movement. So where does a person invest in such a situation to protect himself from interest rate risk and volatility of the stock markets. Capital Protection Oriented Funds could be one of the solutions.

Capital Protection Oriented Funds or CPOFs are closed ended schemes with a lock-in period which seek to protect the investor’s principal irrespective of the performance of the market. This is done by investing a portion in zero coupon discount bonds of quality companies whose maturity is aligned to the scheme’s maturity. This would ensure that the amount invested in such bonds along with the accrued interest would grow to the amount the investor invested at the start. The balance amount available is invested in riskier securities like equities.

Let us understand its working with an example-

Investor A invests Rs. 100000 in a CPOF for a period of 5 years.

Assuming the annualized yield on the bond to be 8 %, an amount of Rs 68058/- will be invested in a zero coupon bond so that it would fetch the maturity amount of Rs 100000/- after 5 years.

The balance Rs 100000- Rs 68058 = Rs 31942 can be invested in high risk-return avenues like equities.

Hence the investment of Rs 68058/- will ensure that no matter what happens to the equity part, the investor’s principal is secured. The equity portion gives the investor the opportunity to earn superior returns while protecting his capital at the same time.

Another variant of the scheme is called the Capital Protection Scheme which invests in the lower yielding risk free government securities instead of debt securities of companies.

CPOFs are not subject to TDS (Tax deducted at source) and the profits are taxed on maturity as long term capital gains with indexation benefits.

CPOFs are only meant for risk averse investors wanting to take an equity exposure and not for those looking at making good returns. These schemes will outperform fixed income investments in stable market conditions, but will not be able to outperform equity mutual funds.

Performance history of some leading CPOFs as on 28^th Sept 2012

*Source – Moneycontrol.com