Definition: How does a Balanced/Hybrid Fund manage interest rate risk?

A Balanced/Hybrid Fund is a type of investment fund that aims to provide investors with a diversified portfolio by investing in a mix of both stocks and bonds. One of the key risks that Balanced/Hybrid Funds need to manage is interest rate risk.

Interest Rate Risk

Interest rate risk refers to the potential impact of changes in interest rates on the value of fixed-income investments, such as bonds. When interest rates rise, the value of existing bonds tends to decrease, as newer bonds with higher interest rates become more attractive to investors. Conversely, when interest rates fall, the value of existing bonds tends to increase.

Managing Interest Rate Risk

Balanced/Hybrid Funds employ several strategies to manage interest rate risk:

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Duration Management: Duration is a measure of a bond’s sensitivity to changes in interest rates. Balanced/Hybrid Funds actively manage the duration of their bond holdings to mitigate interest rate risk. They may adjust the average duration of their bond portfolio based on their outlook for interest rates. For example, if they expect interest rates to rise, they may reduce the duration of their bond holdings by investing in shorter-term bonds.

Asset Allocation: Balanced/Hybrid Funds diversify their portfolios by investing in a mix of stocks and bonds. By allocating a portion of their assets to stocks, which are generally less sensitive to interest rate changes, they can offset the impact of interest rate movements on their bond holdings.

Active Management: Balanced/Hybrid Funds are actively managed by professional fund managers who closely monitor market conditions and adjust the fund’s holdings accordingly. They may make changes to the fund’s asset allocation, duration, and individual bond holdings based on their analysis of interest rate trends and other market factors.

Hedging Strategies: Some Balanced/Hybrid Funds may use hedging strategies, such as interest rate swaps or futures contracts, to further mitigate interest rate risk. These strategies involve entering into derivative contracts that provide protection against adverse interest rate movements.

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By employing these strategies, Balanced/Hybrid Funds aim to minimize the impact of interest rate fluctuations on the overall performance of the fund and provide investors with a more stable return.

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