The Reserve Bank of India (RBI) has raised repo rates by 90 basis points in past two months. This can be seen as a good time to invest in floater mutual funds and to — metaphorically speaking — make hay while the sun shines.
Instead of being tied to funds with lower interest rates for a long time while the overall rates have already risen in the market, some investors consider, therefore, floater funds to be the right choice.
At the outset, we explain what exactly are floater funds:
What are floater funds: Floater funds comprise debt funds that offer a varied rate of returns which change based on fluctuation in interest rates. So, investors can benefit from changes in interest rate cycle.
These debt funds aim to minimise the risk by investing in debt instruments such as corporate bonds, treasury bills, certificates of deposit
How do they work: These funds capitalise on rising interest rates by investing in floating rate bonds which reset coupons at regular intervals. The interest rate given on these funds is linked to a reference benchmark rate on which a spread is added to arrive at the actual coupon rate.
As benchmark rate changes, the coupon offered on the floating rate bond will undergoes a change. Now, since the coupon keeps changing according to higher interest rates, the fund can capture higher yields.
S Sridharan, founder and principal officer, Wealth Ladder Direct said conservative investors can invest in floater funds if they want to stay invested in one-and-a-half years at least.
“Nobody expected interest rate movement to happen so quickly. These funds have to make sure that they don’t get into long duration bonds. Someone who can hold on to these funds for at least a year and a half can earn something around 6 percent,” says Mr Sridharan.
Amol Joshi, Founder of Plan Rupee Investment Services, says “If investor stays invested for the entire interest rate hike cycle, then investing in floater funds make sense. However, if someone wants to invest for short duration, say 6-8 months, then investor should go for ultra-short term funds which have low interest rate sensitivity.”
|Floater Fund schemes||One-year return|
|Aditya Birla Sun Life Floating Rate Fund||3.81|
|HDFC Floating Rate Debt Fund||3.22|
|SBI Floating Rate Debt Fund||3.68|
|Kotak Floating Rate Fund||3.10|
(AMFI data as on June 28)
Some pitfalls: Some experts, however, believe that floating rate funds can, at times, fail to meet the investors’ expectations for a number of factors. At the outset, the floating rate bond market is small in size.
Because of limited supply of floating rate bonds, some funds artificially create floating exposures by using interest rate swaps. What they would do is buy fixed rate bonds and use overnight index swaps to convert fixed interest exposure into floating.
Those who want to keep interest rate sensitivity at bay can choose liquid and ultra-short duration funds which invest in very short duration debt instruments of 3 - 6 months tenure. Short maturity funds are less vulnerable to rising interest rates.