Don’t be surprised and panic when your investments in capital guaranteed funds (CGFs) give you zero returns. This is increasingly becoming the norm for this group of products.
Seen as the closest alternative to the relatively secure fixed deposit (FD), CGFs are designed to safeguard the capital of investors with the promise of returns higher than FD rates.
However, given the challenging economic and stock market conditions, many of these funds have performed dismally in the last one year or so. At best, many dished out marginal returns while others matured at par value, meaning that investors have only got back their capital.
These investors would have fared better had they taken the safe route of placing their money in FDs, which would have yielded a return of at least 2.5% to 3% per annul.
To be sure, there are some CGFs that have bucked the bearish trend and delivered good returns, but these funds are in the minority, say industry players.
Advisor of Retail Fund, says a zero return on CGFs is not entirely unexpected. “Given the investment climate the last one year or so, many funds have performed disappointingly. It was during this period that the global crisis peaked, making it very challenging for many fund managers to deliver returns.”
Still, CGFs, at least in theory, are attractive, and more so to cautious investors. What could be better than an investment product that guarantees to return your cash plus the possible bonus of high returns?
With the recent collapse of global investment banks like Lehman Brothers in the US, the worry about the safety of capital has heightened. Investors were more concerned about the return of their capital than the return on capital.
Another product called the capital protected fund (CPF) is similar in almost all aspects. It promises to protect the capital invested at maturity, except in the case of CGF an additional guarantee is given by a bank, for which a fee is charged to the fund.
Both funds normally have an investment horizon of three to five years.
In the recent past, there has been a huge demand for such schemes going by the incredible growth in this sector. According to media reports, there are now more than 5o such schemes in the market. Assets under management of these funds are estimated to be worth close to RMio billion, representing about 13% of the total asset under management of all private unit trust funds in the country.
Still the question arises as to why many of these funds were unable to at least meet the benchmark FD rates. If these funds had done so, they would have become a more viable investment product for investors bent on staying away from the more aggressive and riskier products.
However, industry players are quick to point out that every investment comes with risks. The problem is this may not have been communicated to the investors at the time of purchase. Like many other unit trusts, most CGF funds are marketed to consumers by banking frontlines, ie, clerks. These personnel may often not be fully knowledgeable about the downside of schemes.
In order to provide the guaranteed feature, normally a large portion of the fund is invested in zero-coupon negotiable instruments of deposit, or ZNID, which are money market instruments. ZNIDs are issued at a discount and compounds at a fixed interest rate to their par value (of i00%) at maturity, thus ‘protecting’ the initial capital. The remaining will be invested in risky assets like stocks, options and currencies.
This is where the leveraging factor or multiplier effects, if any, kick in. For investors who are risk-averse, there seems to be a gap in investors’ expectations.
Despite the low risk nature of CGFs, some of its investors have high expectations of returns, which is unrealistic. It could be that the basic investment rule of low risk low returns’ and ‘high risk high returns‘ does not seem to have been understood well enough by the CGFs investors.
Contrary to the way it is marketed now, some industry players think the products should be marketed passively rather than be sold at banking counters. There should also be better communication to the investors on the potential downside of zero returns. Investors should be asked ‘ are you ok with that zero return?’ This may not be related to potential customers currently.
In the end, though, a lot of disappointment will be avoided if investors themselves read the prospectus and the fine print before investing.