What are the similarities and differences between floating rate funds and liquid funds?
Floating rate bonds and liquid funds are a good option when interest rates are expected to rise. Let us look at the important features of both these funds, when you should invest in them and what their similarities and differences are.
? A floating rate fund invests a major portion of its corpus (about 60-100 per cent) in floating rate instruments and the rest in fixed income securities, while a liquid fund invests in very short term securities such as commercial papers, short-term treasury papers and bank deposits, mostly of a fixed nature.
? When interest rates threaten to rise, investors start thinking about how they can prevent capital loss to their portfolio. In such a situation, floating rate funds and liquid funds can be attractive options.
? Both floating rate funds and liquid funds guard your capital.
? Normally, in equity or an income fund, the redemption is on a T+3 basis, but for cash funds, it is T+1, so you get your cheque the next day.
? When interest rates are likely to go up, liquid funds can be considered a safe haven for investors who have liquidated their income fund holdings and are waiting for the right opportunity to get back into income funds. These investors could look at liquid funds.
? The merit of floaters is self-evident from the returns. The average floating fund has delivered a return of 2.22 per cent as on June 29, 2004 for the past six months, whereas income funds are down 0.05 per cent.
? Liquid fund returns pale in comparison of floating rate funds, but then the liquid fund earns much lower returns as its investments are short term.
? Floaters are mainly instruments for medium term and long term investments, while a liquid fund is essentially a short-term instrument. Due to this reason, floaters carry a CDSC of 3-6 months whereas most liquid funds don't.
? Floating rate funds can invest in long as well as short-term debt instruments, while liquid funds will only invest in short-term debt instruments.
? If interest rates rise, returns from floating rate funds would rise immediately (as the coupon on floating rate bond readjusted frequently). However, in case of liquid funds, the return would rise with a lag of a month or two.
? For an investor, the most important question is what he will earn on an investment. The answer to that is that the floating rate fund would give better return than the cash fund, but over the long-term.