Floating Rate Funds: Should you invest in it?

Floating rate funds are a class of debt funds that must divide at least 65% of their assets in floating rate instruments. These instruments are issued by the central and state governments and corporates. They carry a variable interest rate attached to the Mumbai Interbank Offer Rate (MIBOR).

Generally, the performance of these funds is good when interest rates are increasing. This is because the interest rate on underlying bonds is reset as per the existing interest rates. The data from the Association of Mutual Funds in India (AMFI) suggests that floating rate funds see strong inflows even during tighter liquidity conditions.

While this appears simple, it is vital to know that few institutions issue floating-rate bonds. Thus, these funds rely on a derivative strategy to meet the need of investing at least 65% of their portfolio in floating rate bonds by using interest rate swaps and fixed-rate bonds.

Benefits of investing in floating rate fund

• Flexibility

Since these funds are open-ended, there are no restrictions on entering or exiting the fund. There is flexibility. When you expect the interest rate to increase, you can use your surplus cash to invest in floating-rate mutual funds. But if you expect the scenario to change, you can choose to exit the fund.

• Reduction in duration risk

When it comes to fixed-income schemes, duration risk is the risk of a decline in the value of your fixed-income investment against a rise in interest rates. The risk is higher when you invest in fixed income securities for long. The risk with floating rate funds is very low compared to portfolios with longer-duration fixed-income schemes.

• Diversification in fixed-income portfolio

The interest rates on the securities in a debt fund or fixed-income portfolio are fixed. But, the investments of a floating rate fund are in different types of fixed-income securities having variable interest rates. As a result, the investor’s portfolio is diversified and reduces overall portfolio risk.

Is it a good idea to invest in these funds?

Retail investors must cautiously make investments in this category. Floating rate funds offer returns when interest rate movements are favorable. Investors hold the funds till maturity, which is approximately 2.5 years. Therefore, investors should evaluate its performance against investments in the short-duration category. Floater funds are also less volatile in relation to the short-duration category funds. But, these funds are not credit risk proof. There is a need to evaluate the funds individually before investing.

Although these funds are beneficial during the rising rate scenario, experts believe they are an all-year-round fund. Investors can enter and exit the fund as per their preferences. SIP in floating-rate funds is a good move for investors who have a two to three-year horizon. These bonds protect investors against volatility in interest rates.

Summing up

Floating rate funds optimize the flexibility of managing the risk of interest rate. Moreover, they increase investor returns through accrual earnings. With the benefits of lower net duration risk and good credit quality, these funds are suitable for fixed-income investors who want to increase returns during an increasing rate environment. You can now get ready to invest in floating-rate funds in just a few minutes with the Tata Capital Moneyfy App.