Floating rate funds are in the limelight. Faced with the prospects of a rising interest rate scenario, investors are seriously weighing their options to invest in the debt fund segment. And floating rate funds look like a natural choice. Floating rate funds invest in instruments which have a coupon rate that is linked to a market benchmark. Since the interest rate changes in the money market reflects in the benchmarks, the coupon rate in these instruments will also change accordingly. Usually, the rates are reset after a period of three or six months.
That sounds credible, but is it the best way to hedge your interest rate risk? Has the time of floating rate funds come? To a certain extent the answer is affirmative. However, these days there is not much difference between liquid funds and floating rate funds. Liquid funds also tend to have a lot of floating rate instruments in their portfolio. So, you could also consider liquid funds if you are parking the money for a short period. That means if you are parking money for medium term, you still have to bank on floating rate funds.
If the rates are going up in the money market, the investor may benefit from investment in floating rate funds. However, if there is a change in the liquidity in the system, the opposite could also happen. A solution for this is to go for a fixed maturity plan or FMP. In an FMP you lock in your funds for a certain period, say, six months or a year. These funds try to invest in instruments which match the maturity of the plan. Since the investor is locking in the interest rate for a certain period, interest rates risk is nil in an FMP. That is not the same in a floating rate fund, where the investor always exposed to the risk of a downside in interest rate,
FMP are essentially close-ended mutual fund schemes with a fixed maturity. They come with disparate maturities like three month, six month, and one year among others like a fixed deposit. As with term deposit, investors can exit these schemes after paying a small penalty. The fund will specify the benchmark against which the performance of the scheme is measured.
Since it is a close-ended scheme, the fund manager will ensure that the maturity of the portfolio matches the maturity of the scheme. This will ensure that the scheme will not be affected by interest rate volatility. This also helps investors to find out the likely returns on maturity by deducting the expenses from the current benchmark returns. FMP are ideal for people looking to park money for a fixed term in a mutual fund scheme, but donâ€™t want to be worried about fluctuations in NAV (net asset value) or interest rates.