Are “Capital Guarantee” Funds Always the Best Choice?

“Capital guarantee” has a reassuring ring to it. Your money is safe, the fund promises not to lose it, and what could be more sensible than that? So it is no surprise that many employees, and many HR teams, treat the capital guarantee fund as the obvious pick under the new End of Service Benefit (EOSB) savings scheme.

The honest answer, however, is: it depends. For some employees it is the only option, for others it is exactly right, and for a third group it can quietly cost tens of thousands of dirhams. (A quick note on wording: “capital guarantee” is the term used in the law. As we have pointed out in our Provider Spotlight series, the protection comes from what the fund invests in and, in some cases, from a reserve mechanism, rather than from an ironclad promise.)

Who must use a capital guarantee fund?

Unskilled workers, and anyone earning less than AED 4,000 a month, must use the capital guarantee fund under Article 8 of Cabinet Resolution 96/2023. Only skilled workers can choose.

Let's start with the law. Cabinet Resolution No. 96 of 2023 sets out the investment options in Article 8. According to the English translation published on u.ae, the capital guarantee option, “a risk-free option for capital preservation”, is the option for unskilled workers, whereas “a skilled labour beneficiary may choose any investment option”.

And who counts as skilled? Article 1 defines skilled labour as: “Professional level workers (first to fifth levels), whose monthly salary is at least (4,000) four thousand dirhams.”

In plain terms: if you are an unskilled worker, or you earn less than AED 4,000 a month, the capital guarantee fund is where your savings go. Only skilled workers get to choose.

We fully understand this. Blue-collar workers tend to be ill equipped to take investment decisions, and a protective option makes sense for people who cannot afford to lose a single dirham of their savings. For this group, the question in our title simply does not arise.

How should skilled workers choose an EOSB fund?

By time horizon: the longer you have until you leave or retire, the more risk you can afford to take, and the shorter it is, the less.

For skilled workers, the right answer depends on personal circumstances, and the single most important one is time horizon. As a rule of thumb: the longer your horizon, the more risk you can afford to take, and the shorter your horizon, the less. Let's look at both ends of the spectrum.

How much can a capital guarantee fund cost over the long term?

In our 10-year example on AED 15,000 a month, the capital guarantee fund ends at about AED 162,000 and a risk-based fund at about AED 219,000, a gap of about AED 58,000.

Imagine a young employee with several decades to go before retirement. (Personal circumstances always matter, but bear with us.) Here is a simple, illustrative scenario:

• Salary: AED 15,000 a month (treated as basic salary), with more than five years of service. The employer therefore contributes 8.33%, or about AED 1,250 a month.

• Capital guarantee fund: a return of 2–3% a year, less costs of about 1%. That leaves roughly 1.5% a year, and after inflation there is little or nothing left.

• Risk-based fund: a return of 8–9% a year, less the same 1% costs. That leaves roughly 7.5% a year.

• Period: 10 years, with contributions only and no extra top-ups.

• The result after ten years, on AED 150,000 of contributions paid in:

• Capital guarantee fund: about AED 162,000

• Risk-based fund: about AED 219,000

The difference: about AED 58,000, or roughly 36% more, equivalent to nearly four years of contributions.

And that is only ten years. Compounding does its best work over decades, so for a 25-year-old the gap would be considerably larger. “Safe” is not free: the price is the upside you give up.

When is a capital guarantee fund the right choice?

Close to retirement: a 20% market fall one year before exit would wipe out about AED 44,000 with no time left to recover.

Now for the other side of the coin. Higher expected returns come with higher volatility, and volatility is a nuisance when you are close to the exit.

Fast-forward to our employee, who has enjoyed average returns of 8–9% over the years and now has about AED 219,000 in a risk-based fund. Retirement is one year away. Then, shock: the AI bubble bursts, stock markets fall sharply, and the fund is down -20%.

The employee retires with about AED 44,000 less than a year earlier, nearly three years of contributions gone. With only twelve months to go, there is no runway left to recover. It would have been far more prudent to switch to a lower-risk fund, such as a capital guarantee fund, as retirement approached.

So, are capital guarantee funds always the best choice?

No. They suit short horizons and are mandatory for unskilled workers, but long-horizon savers usually give up a lot of upside.

• It depends on your time horizon. There is no single “best” fund, only the best fund for a particular person at a particular stage.

• Long runway: a capital guarantee fund is probably not a good idea, because you forgo a lot of upside.

• Short runway: a capital guarantee fund is a good idea, because you cannot make up for losses in the time you have left.

  
  

In other words, the smartest approach is often not one fund for life but a plan that moves from higher risk to lower risk as retirement approaches.

What does this mean for HR when choosing a fund manager?

Choose based on the profile of your workforce: you need a strong capital guarantee offering for blue-collar staff and a broad range of risk-based funds for young professionals.

If you are choosing a fund manager for your company, the profile of your workforce should drive the decision. A workforce that is mostly blue-collar needs a strong capital guarantee offering, because that is where those employees' savings must go. A workforce with many young professionals needs a broad range of risk-based options, so that employees are not forced into “safe” choices that cost them dearly over time. And most companies will have both.

This is not a decision to guess at. We recommend independent professional advice, for example from us: GratuityAdviser is operated by Lux Actuaries Financial Consulting L.L.C., which holds a Category 5 (Financial Consultations and Introductions) licence from the UAE Capital Markets Authority (CMA), and is qualified and authorised to advise on exactly these matters. Details are here.

For help preparing your organisation, or comparing and evaluating providers, please get in touch with us.

GratuityAdviser is operated by Lux Actuaries Financial Consulting L.L.C., which holds a Category 5 (Financial Consultations and Introductions) licence from the UAE Capital Markets Authority.