Protected Fund

What Is a Protected Fund?

A protected fund is a type of mutual fund that promises to return at least some portion of the initial investment to an investor. The protected initial investment, plus some capital gain, will be returned as long as the investor holds the original investment until the end of the contractual term.

The idea behind this type of fund is that you will be exposed to market returns because the fund is able to invest in the stock market, but you will have the safety of the guaranteed principal.

How a Protected Fund Works

A protected fund often holds a mix of fixed-income and equity investments. The fixed-income portion of the portfolio partially guarantees the principal investment, while the equity portion seeks additional gain. The portfolio manager will often purchase an additional insurance policy to protect the principal, the cost of which is passed on to the investor.

The initial investment can only be paid back after the guarantee period is over; if the investor sells before this period, they are subject to any losses as well as possible fees for early redemption. This type of fund tends to have higher expense ratios than other types of mutual funds.

Examples of Protected Fund Construction

Zurich Life offers a line of three protected funds that can serve as an example of how these funds work:

• The Protected 70 fund invests up to 90% of its assets in equities. The protected price is equal to 70% of the highest unit price during the investment period.
• The Protected 80 fund invests up to 70% of its assets in equities. The protected price is equal to 80% of the highest unit price during the investment period.

You should consider the following before investing in a protected fund:

• Do you need your money in the next five to 10 years? If you liquidate early, you may lose your principal guarantee, have to pay an early withdrawal penalty, and could lose money if the share price has fallen since your initial investment.
• Do you need any income from the investment? The guarantee is based on taking no redemptions during the guarantee period and reinvesting all dividends and distributions.
• Unless held in a tax-deferred retirement account, you must pay U.S. income tax.
• You might achieve no gains above your initial investment. In this case, your performance would trail that of Treasury bonds purchased with no annual fees.
• You will only receive the benefit of the guarantee on the maturity date.
• How good is the guarantee? The guarantee the fund provides is only as good as the company that gives it. While it is an uncommon occurrence that the banks and insurance companies that typically back these guarantees are unable to meet their obligations, it happens.