Capital Guarantee Fund
What Is a Capital Guarantee Fund?
A capital guarantee fund is an investment wherein the investor's principal is protected from any losses. With a capital guarantee fund, any losses experienced by the underlying investments are rather absorbed by the fund company.
These funds subsequently will generally invest the majority of their accessible capital in exceptionally conservative securities to assist with limiting the probability of losses, a move that likewise limits return. A capital guarantee fund may likewise use derivatives, for example, options contracts to guarantee against losses, which can likewise reduce returns due to the cost of purchasing the options.
These funds are pooled investments managed expertly and may likewise be alluded to as "capital-protected funds." These ought not be mistaken for principal protected notes (PPNs), which are a type of structured product that likewise guarantee against losses, however which are complex and accompanied unique risks.
How Capital Guarantee Fund Work
Capital guarantee funds basically give a risk-free investment. However, while the downside is protected from losses, investors in these funds likewise sacrifice some potential for upside appreciation. Capital guarantee funds are progressively famous and are presently offered around the world, including several distinct types of underlying investments.
To limit the fund's risk of engrossing losses, fund managers will keep the majority of underlying assets conservative in vehicles like bonds. They might invest a small percentage of higher risk equity securities. Different times, the fund can utilize options to hedge downside risk, or as a speculative portion to leverage upside.
For example, one strategy that can be utilized is to invest in profoundly evaluated zero-coupon corporate bonds developing in 10 years. These bonds, since they don't pay customary interest, are sold at a discount and gain value after some time, at last developing at face (par) value. Say the face value on these bonds are $1,000 and are issued at a discount in the market at $915 per bond. On the off chance that the fund has $10 million to invest, it can buy 915x bonds for $9,150,000, which will mature to the initial principal amount of $10 million of every long term's time. The leftover $850,000 can be invested a way the fund sees fit to create returns. Since this speculative amount staying just addresses 8.5% of the fund's accessible capital, fund managers will generally utilize exceptionally leveraged, however limited downside securities like options or different derivatives.
Investors ought to take care of any outstanding concerns on these funds since they can be structured in various ways and at times, just a percentage of capital might be guaranteed against losses.
Important Considerations
While offering a capital guarantee on the investment, capital guarantee funds are generally known for illiquidity. These funds don't offer simple access to invested cash and capital invested will be locked in for different time spans.
Generally, a capital guarantee fund will expect that an investor remain invested for a certain number of years, making these investments best for investors with a long-term investment goal. Illiquidity is a primary characteristic of capital guarantee funds in view of their organizing. Regularly, a capital guarantee fund will utilize the invested capital to invest in generally safe fixed-income securities, for example, bonds, which need time to arrive at maturity and repay invested principal.
Capital guarantee funds might offer some return benefits for long-term investors alright with the investment's inherent illiquidity. The returns on these funds can for sure be significantly higher than savings accounts or money market returns, which additionally have no potential for loss of principal.
Note, but that the returns produced from these funds are commonly taxed as ordinary income instead of capital gains or tax-advantaged dividends. Moreover, fees can be higher than commonplace mutual funds, and are charged by the fund to fund the derivative positions used to guarantee the principal returns and limit risk.
One last consideration is that funds that utilize principal protection just ordinarily guarantee the notional amount, and don't account for the effects of inflation after some time. Accordingly, assuming you invest $100 today and receive $100 in 10 years time, the genuine value of that $100 has declined in terms of purchasing power due to inflation.
Illustration of a Capital Guarantee Fund
Prudential has been a leader in the capital guarantee funds market. It presented capital guarantee funds backed by Prudential Retirement Insurance and Annuity Company (PRIAC) with targeted maturity dates through 2025. It likewise offers capital guarantee funds through defined contribution plans. Moreover, it has a Guaranteed Retirement Income platform from which various capital guarantee investments are offered.
Features
- Capital guaranteed funds are pooled investment vehicles that give principal protection to investors.
- Capital guaranteed strategies will quite often be long-term and illiquid due to how they are structured, implying that investors might lose principal assuming they pull out their money too early.
- These funds will generally utilize okay instruments as well as utilize derivatives strategies to shield from losses yet in addition give some positive return potential, albeit limited.
