What is Floater Fund?
Floater Fund is an open-ended debt scheme that invests more than 65%
Floater funds benefit from the fluctuating interest rate situation
When investors’ goals are short-term, and the risk tolerance level is low, debt funds are preferable as they are much less volatile than equity funds. Floater funds are debt funds, like income funds, gilt funds, dynamic funds, etc. In this article, the essential aspects of floater funds are discussed for the investors.
What is Floater Fund?
Floater Fund is an open-ended debt scheme that invests more than 65% of its total assets in floating rate instruments, such as corporate bonds and debt instruments or loans from companies with variable or floating interest rates. The floater funds have no fixed coupon rate.
How interest rates influence Floater Funds?
The interest rates prevailing in the market primarily determine the interest rate of the floating funds. Although every floating rate instrument has a specific benchmark, the interest rate of a benchmark fluctuates. The interest rate of these financial instruments also keeps on changing as per the benchmark rate.
The return of any debt instrument is affected by the repo rate changes by the Reserve bank of India (RBI). With the increase in the market lending repo rate, these floater funds’ interest rate also increases. This change is reflected in NAV units of these funds that allow higher returns to the investor.
How do floater funds work?
Floater funds benefit from the fluctuating interest rate situation and generate quality returns for investors. Unlike corporate bonds, which have a fixed coupon rate, floater fund securities have variable or fluctuating interest rates. With the increase in the interest rate in the debt market, floating instruments’ interest rate also rises. As the floater fund comprises of these instruments, they yield a higher return. Thus, when the interest rates rise in the country, these funds offer better returns than fixed-income rate funds. Therefore investors usually switch to floating rate funds in such a scenario.
Who should invest in floater funds?
Floater funds are for investors with lower risk tolerance, and this fund is highly sensitive towards interest rates. In case the country’s interest rates fall, the floater fund can deliver lower returns than other fixed-income funds. Moreover, credit risk is attached to them as there is a chance of default in payment of the underlying security. The investors for fixed income investments can choose this fund as an additional option if financial goals match the fund.
Types of Floater Funds
Short-term Floater Funds
These funds primarily invest in short-term debt instruments with short duration maturities, such as certificates of deposits, T-bills, and government securities that are highly liquid.
Long-term Floater Funds
The majority of these funds’ portfolio consists of floating-rate debt instruments with a long term maturity period. The balance part of the portfolio is invested in money market instruments or fixed-rate securities.
Features of Floater Funds to Consider before investing
A diversified portfolio of debt securities consists of both floating rate instruments and fixed-income securities. However, 65% of their primary assets are put in floating-rate securities, yielding better returns when the interest rate is rising. The rest of the fund consists of fixed-income securities.
The floater fund is a safer investment option. But like any debt instrument, there is credit risk involved. The risk occurs when the bond defaults its due payment. It is always preferable to invest in securities with a high credit quality or rating where the default risk is minimal.
In the long run, floater funds yield better returns than other fixed-income instruments, bank deposits, bonds, etc. Compared to short-term debt funds, these funds have low volatility, and one can leverage the benefit during rising interest rates movement in the economy. This opportunity can yield better returns; however, it is not justified with higher interest rate risk.
The taxation is of two types as usual for debt mutual funds. If the holding period is below three years, short term capital gains tax levied as per the income tax slab rates. Else the capital gains tax liability is 20% with indexation benefit or 10% without indexation.
Open-ended Debt Scheme
The investor can enter or exit the fund any time after the NFO (New Fund Offer) as per his needs and financial goals.
In the case of a floater fund, it is essential to analyse and predict the market economy before deciding. Moreover, an investor needs to tune his investment to the financial goal. Consult your advisor to make the right decision.
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