Is Capital Guaranteed Fund a Good Investment?

Follow up to the inquiry from one of this blog reader who wants to know more about zero-coupon negotiable instruments of deposit (ZNID) and capital guaranteed fund, we will discuss the features and benefits of investing in capital guaranteed fund in this post.

Definition of Capital Guaranteed Fund (CGF)

CGF is an investment vehicle offered by certain institutions that guarantees the investor’s initial capital investment from any losses. When you invest in a CGF, it is guaranteed that you will not lose any money provided that you didn’t redeem your investment before the maturity date.

The Guaranteed feature
In order to provide the safe and guaranteed feature, a large portion of the fund is invested in investment instruments that guarantee the return. Thus, the best option is to invest in ZNID.

For example, let’s look at the ING AsiaPac Capital Guaranteed Fund. It is clearly stated in the prospectus that the Fund will invest 85% in 3-year Ringgit denominated ZNID at inception. The ZNID are issued at a discount by a consortium of banks. When the ZNID expires in 3 years, the mature value is equivalent to the initial capital raised.
How guarantee is this ZNID? It is actually very guaranteed because banks are governed by Bank Negara Malaysia and all deposits are insured with deposit insurance. ZNID is definitely lower in risk compared to corporate bonds.

Enhancement feature
The rest of the fund will be invested in other places which is not guaranteed. When the fund mature, investor will be getting back the initial capital injected, plus all the other returns made from the extra exposure.

Image: Illustration of Capital Guaranteed Fund

Features of Capital Guaranteed Fund

1. High asset allocation in guaranteed investment instruments such as ZNID. Normally up to 80-90% of total fund size
2. Benchmark comparison with Fixed Deposit Rate because it is just slightly higher risk than FD.
3. Investment horizon is normally 3-5 years
4. Normally most CGF are offered during offer period. After the closing date, there will be no more subscription accepted.
5. Normally the value per unit starts at RM1.00 for ease of return calculation
6. Higher initial investment compared to other unit trust fund. The minimum amount normally starts at RM5,000
7. Not so high entry fee. The service charges is 1.5% practiced by the industry at this moment.
8. There is a redemption fee before maturity, range from 0.3% to 1.5% of NAV
9. Capital preservation feature – guaranteed!
10. If you missed the offer period, you can’t invest in the CGF. Just wait for another series to be launched.

Three Phases of a CGF

Image: 3 phases of a CGF
Source: SIDC Malaysian Investor

From SIDC Malaysian Investor, here is the explanation of the guarantee factor:

Let’s assume that you bought units in a CGF at an Initial Selling Price of RM0.50 per unit. The fund maturity period is three years. You invested RM5,000 in exchange of 10,000 CGF units. When the maturity date arrives, the net asset value of the funds is only RM0.40 per unit. Since it is a CGF, you will receive RM0.50 per unit when you redeem your fund, instead of RM0.40 per unit. Basically, the guarantor of the fund will pay for the RM0.10 difference. In this case you will receive RM5,000 after redeeming the 10,000 CGF units. Without the guarantee you would have lost RM1,000 and would only receive RM4,000 (excluding fees and charges).

However, if on the maturity date the net asset value per unit is RM0.60, the guarantee will not be triggered and the redemption value of each unit will then be based on the actual net asset value per unit of the fund. In this case, you will receive RM0.60 per unit rather than RM0.50. Therefore you will receive RM6,000 for redeeming your 10,000 CGF units (excluding fees and charges). Your profit is RM1,000.

Nonetheless, the guarantee is only applicable for units that are held until the Maturity Date in this example, three years. If the units are disposed before the Maturity Date, the guarantee will lapse and investors’ capital will no longer be guaranteed and will be exposed to potential capital lost. For some CGF, penalty will be imposed for early redemption. You must consider all these factors to ensure that investing in the CGF is consistent with your investment plan.

In real situation, banks are the one who wants their money guaranteed. Still remember when you borrow your study loan, the bank requires guarantors in order to release the money to you. Thus, the banks are not stupid. That’s why you won’t see any bank actually becomes the guarantor of CGF. Instead, they issue ZNID to the fund house in order to provide the guarantee feature. Banks get the money in advance, use it to earn more returns through providing financing services, and then provide the guaranteed return when the ZNID matures.

Are you interested in CGF?

You will be interested to invest in CGF if:

• you are seeking to preserve the value of your capital, no matter how the market perform
• you have a very low risk tolerance
• if you like FD a lot, CGF just suits your taste
• returns is potentially higher than FD interest.
• you won’t need the money until maturity
• you are a retiree or approaching retirement soon.

Consider these risk involved:

• in case of emergency, you will lose some capital upon redemption before maturity date. Be prepared to pay the penalty charges or redemption fees. Don’t invest in it if you can’t afford to wait until the maturity date.
• Even though the SC’s Guidelines on Unit Trusts requires the guarantor to have a good credit rating from either domestic or global rating agency, there’s always the risk of default by the guarantor. Bank can also goes bankrupt 🙁 The deposit insurance doesn’t guarantee the full amount of deposits either.

Before you jump into the bandwagon, it is better to review your situation at this moment. As written by Connie Ong:

Let’s start by first considering a typical portfolio holdings of the man in the street. As you read on you will find that most of us are already quite well capital preserved by virtue of the availability of the following typical investments: –Fixed Deposits.
Aside from a savings and checking accounts, we are very likely to also hold fixed deposits. As the government backs deposits with Malaysian banks, the capital in our fixed deposit investment is in most ways already guaranteed.
EPF Accounts.
Despite all the recent public criticism on the way EPF handles our investments, it is a known fact that their investment policies are guided strictly by very specific limits on investment product. On a very basic level, the EPF is primarily allowed to invest in fixed income instruments which are government backed or highly rated by the Rating Agency Malaysia Berhad (RAM). Only 20%-30% can be invested in the supposedly volatile stock market. Even if the EPF invested only invested 50% of its pool of funds in strong credit fixed income instruments as mentioned above, this 50% pool would return you 100% after 12 years (assuming a 6% average return rate) irregardless of what happens to the balance 50% investment, hence your capital is preserved.
Endowment policies.
Life insurance companies adopt very similar policies in allocating their investments as EPF hence giving protection to the promised insured sum. The risk of unanticipated claims as a result of catastrophes like September 11 is also lessened through reinsuring the liabilities to their fellow insurers in order to spread out large event risks.

After all the arguments, we should come back to the very basic fundamental of investment.
Do you properly apply a suitable asset allocation for your investment portfolio?
Do you do portfolio rebalancing regularly?

CGF is definitely a low risk unit trust investment, even lower than bond funds. You can include CGF in your low risk portion of your asset allocation strategy.

CGFs for Malaysian Investors

• ING AsiaPac Capital Guaranteed Fund – invest in ZNID and ING AsiaPac Index Option, comprising of 5 Asia Pacific market indices.
• OSK-UOB Capital Guaranteed Funds Series – invest up to 20% of initial capital raised in an actively managed portfolio
• Mayban Capital Guaranteed Trust Fund series
• RHB Unit Trust – Asia Pacific Fund – invest in ZNID and Capture the Peak Options, which is linked to the performance of a basket of 10 Asia Pacific stocks in the infrastructure and energy sectors
• Hwang-DBS Capital Guaranteed Fund – At least 80% in ZNID and the balance in equity and equity-related securities on the Commencement Date.
• CIMB Bank’s Dynamic Growth plus Income Capital Guaranteed FRNID (floating rate negotiable instrument of deposit) yesterday.
• AmMutual’s AmMulti Assets – Capital Guaranteed: invest 85% in ZNIDs, AmInvestment Bank Berhad as guarantor.

If you know any other CGF not listed here, please reply in the comment and I’ll add it to the list.

Other related articles, which I think you shouldn’t miss:
Investment replacement feature is not available in unit trust
Bottom Up approach in unit trust investment
Top-down approach in unit trust investment
Unit trust company list in Malaysia
The secret of investing in unit trust

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