Floating rate debt funds aka floater funds are open-ended debt funds. These funds invest in debt instruments with varying(floating) interest rates.
The interest rates of underlying debt instruments rise as the RBI repo rate goes up. Hence, floater funds tend to perform better during rising interest rates compared to other Debt funds.
In a rising interest rate regime like the one we are going through currently, investors have a good possibility of earning superior returns compared to fixed interest rate instruments.
As the interest rates are locked in the latter and can't be readjusted to the new increased rate which makes floating rate debt funds one of the best asset classes to hold in a rising interest rate scenario.
As per SEBI guidelines, fund houses invest at least 65% of the total corpus into floating-rate debt instruments.
There are two types of floater funds:
Short-Term Floater Funds-
Short-term funds invest primarily in debt instruments with short maturity periods and higher liquidity. For example- Government securities and T-bills.
Long-Term Floater Funds-
Long-term floater funds invest in debt instruments with longer maturity horizons such as corporate bonds and government bonds.
Floater funds deliver superior returns compared to other debt funds or fixed-income instruments. Investors can expect to earn more profits from floater funds during rising interest rates.
Investors can invest in floater funds anytime, with a flexible horizon. You can select a short or long-term horizon depending on your investment goals. And you can invest/sell these funds whenever you want.
Floating rate debt funds invest at least 65% of the total corpus into various debt instruments. Fund houses might invest the remaining funds in fixed-income instruments.
You have the opportunity to invest in Government & corporate bonds, T-bills, and loans. With a blend of varying and fixed-income rates, you can achieve a diverse portfolio.
Most debt funds carry credit risk and interest rate risk. But floater funds are less riskier as they carry very little to no interest rate risk.
Interest rates of the underlying bonds in floater funds often align with the market interest rate. So the risk associated with interest rates is quite low compared to other debt funds.
While there is a slight possibility of credit/default risk, it can be avoided by choosing the right funds. Only invest in funds with higher ratings (above AA). This rule is applicable to all types of debt funds so you won’t have to face default risk.
Consider holding your investment for more than 3 years. You have a chance to earn better returns and tax benefits.
But, you can also explore short-term funds which may deliver superior returns to fulfill your envisioned investment goals.
Carefully choose the investment tenure that aligns with your portfolio.
Floater funds perform better during the rising interest rate scenario. You may earn exponential gains when interest rates are rising.
But keep in mind that the RBI repo rate directly affects the interest rate. Don’t consider investing in these funds when the interest rates are falling or may fall.
Floating rate funds may lower the overall risk on your portfolio. If you invest in funds with good ratings, you won’t come across default risk.
These funds could be a good addition to managing the risk and also include various debt instruments to your profile.
Fund houses will charge a certain amount of fee aka expense ratio to manage your funds. Evaluate the expense ratio with respect to possible capital gains before investing.
Please know that a lower expense ratio doesn’t necessarily mean higher capital gains. In some cases, you might earn even higher returns through a fund that charges a slightly high expense ratio.
You may also want to consider comparing the expense ratio of funds from similar categories and tenure.
Investors have to pay tax on both Short and long-term capital gains from floater funds.
Investors who are looking for competitive returns with lower risk can consider investing in these funds. Floater funds may deliver better returns for the same maturity period than other low-risk investment options.
If you are aiming to diversify your portfolio but don’t want to go with fixed-rate debt funds, then these funds can be for you.
We highly recommend considering all the above points before you invest in floater funds or any other mutual funds.
Or you can get in touch with our advisors for more details.
Floating-rate debt funds have flexible maturity periods. These funds can boost your overall investment portfolio during rising interest rates.
However, keep in mind that repo rate fluctuations have a direct impact on these funds. You might come across interest rate risk when the repo rate goes down.
Invest in funds with higher ratings and only during rising interest rates.
If you are interested in debt securities, you can give us a call or send us an email. Advisors at VNN Wealth have been analyzing debt funds for a while now.
Review your portfolio and risk profile with us and make a solid investment plan.
You may also like to read about different types of mutual funds.
Learn some easy personal finance tips here.
