12th August 2006: The Securities and Exchange Board of India (Sebi) has given the green signal to mutual funds to launch “capital protection-oriented schemes,” under which investors are assured of their capital invested even if the scheme underperforms.

As per Sebi guidelines, capital protection schemes have to be close-ended. However, investors investing in such schemes will not have an exit option before maturity. Among the guidelines stipulated by Sebi, asset management companies will not be allowed to repurchase units of a capital protection scheme before maturity.

But the asset management company (AMC) will not be allowed to repurchase the units of such a scheme before maturity. Also, AMCs will have to get such a scheme rated by a registered credit rating agency “from the viewpoint of the ability of its portfolio structure to attain protection of the capital invested therein,” the Sebi release said.

In some ways, the capital protection scheme is a form of an assured return scheme, which Sebi had banned some years back. The key difference here is that the AMC is assuring the investor of protecting his capital, and not returns, as used to be the case earlier.

Industry watchers feel this move could attract more retail money into the mutual fund industry, which has already been witnessing a good interest from that quarter of late.

“A significant portion of the fund — say up to 80-85% — is likely to be invested in highly-rated debt instruments, including government bonds,” said the CEO of a private mutual fund, on how capital protected schemes were likely to be structured.

“That will ensure protection of the capital to a large extent. The remainder will be invested in equity, allowing the investor to benefit in case the stock market does well,” he said. From an AMC’s point of view, shortfall on maturity is unlikely to be substantial due to the higher component of debt in the scheme.