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Unguaranteed Returns

If you are being led to believe that capital protection-oriented funds will rocket up during bull runs and then miraculously not fall when the markets crash, then you are being taken for a ride

We're all very fond of guarantees. I don't think anyone of us would even dream of buying something like a TV set or a car without a guarantee, or indeed, whether TV or car manufacturers would dream of trying to sell their products without a guarantee. And now we have a fund - Franklin Templeton Capital Safety Fund - that's sort-of guaranteed. This fund does not actually come with a guarantee. Instead, Franklin Templeton's description of this fund has the same approach to the idea of guarantee that the dialogue of Dada Kondke's films has to sex - everyone knows what is actually being talked about, but no one can prove it.

Anyway, we're now set for many more of such funds. For quite some time now, the word in the mutual fund industry has been that capital-guarantee funds are on their way. These are supposed to be funds where there is a guarantee that the investors' capital will not be eroded. No matter how bad things get, at least the initially invested amount will always be protected.

In August this year, SEBI came out with the regulations under which such funds can be launched. SEBI's regulations on the matter were an interesting exercise. The regulations carefully tip-toed around the word 'guarantee' without quite mentioning it, thereby setting the stage for this new guarantee-suggestive style of describing funds' objectives. The regulations pave the way for the launch of what it names 'Capital Protection Oriented Schemes'. It says that these will be schemes that will 'endeavour' to protect the capital invested in them. The regulations also state that the funds will be rated by a credit rating agency 'from the viewpoint of the ability of its portfolio structure to attain protection of the capital invested therein'. Translated from Legalese to English, what this means is that such funds will try hard not to lose your money and they will be certified by a rating agency as having tried hard enough. But do note that we are only talking about an effort to protect capital no one has said anything about the effort actually having to succeed.

Will such funds actually deliver what they promise? My opinion is that they will deliver what they actually offer, but will substantially fail in delivering what most fund salesmen will orally promise in their sales pitches. This fund, (and probably others that will follow it) is basically an MIP with a more attractive packaging. Like many other MIPs that already exist, it will invest your money in debt with a little bit in equity. If things go well in the stock markets, it will deliver a few per cent more than what you would get in a bank FD, which by itself is not a bad deal. If the stock markets do badly, then it will try to gain in debt what it loses in equity and thereby manage to protect your capital. CRISIL (a rating agency) has rated the fund as having the 'highest degree of certainty regarding payment of face value of investment to the unit holders'. However, if you are somehow being led to believe that such funds will rocket up along with the Sensex during bull runs and then miraculously not fall when the markets crash, then you are being taken for a ride.

Fundamentally, there is no way to reap the full rewards of equity without also facing its full risk. Chasing vague guarantee-like promises is not the way to do it.