Why floater mutual funds are the
flavour of the season

Off late, floater rate mutual funds have been attracting a lot of attention and investment towards it. A recent report by Moneycontrol stated that investors are expecting the Reserve Bank of India to hike interest rates this year, and it has been driving them to invest their money in these floating rate funds with a positive hope.

So, what’s making these floating rate funds the flavour of the season? Let’s take a look.

First off, what are Floater Mutual Funds?

Funds that invest majorly in financial instruments that offer variable interest rates such as bonds and bank loans, are known as Floater Rate Mutual Funds. Now, these investments are usually of shorter durations compared to other medium term debt category mutual funds. They can navigate through the market interest rate changes, and the returns offered by floater funds are higher than those offered by conventional fixed-income investments like bank FDs.

These funds aim to invest at least 65% of their assets in floating rate bonds issued by corporations, and the central and state governments, which pay a variable interest rate based on the Mumbai Interbank Offer Rate (MIBOR).

How do they work?

To manage interest rate risks, these funds use Overnight Index Swaps (OIS), an interest rate swap agreement where a fixed rate is swapped against a predetermined public index of a daily overnight reference rate, such as NSE MIBOR.

In an OIS, two parties agree to trade the difference in accumulated interest on the notional principal amount calculated using fixed and variable interest rates at maturity.

Floating rate funds often invest in a mix of sovereign, corporate, money market, and interest rate swaps and have a two-year tenure. AAA-rated instruments account for a major share of the portfolio as these funds are less volatile than longer duration funds.

What is attracting the attention towards them?

According to data from Association of Mutual Funds in India (AMFI), floating-rate funds have got inflows worth over Rs. 23,000 crores so far in 2021.

The expectation of a possible rise in interest rates later this year or early next year is driving many investors and distributors towards floating-rate funds.

Benefits of investing in floater mutual funds

Mixed portfolio of debt securities: Floater funds invest the majority of their assets in floating rate instruments, which provide high returns during periods of favourable interest rate movement. The remaining assets are invested in fixed-income securities. In the long run, this diversification across debt instruments leads to higher returns.

Open-ended schemes: The majority of floater funds are open-ended, which means they have no investment constraints. Individuals interested in purchasing NAV units of such mutual funds can do so at any time at the trading value established by the underlying assets’ value, as opposed to closed-ended funds, which must be traded within their NFO period.

Less Risky: Senior secured corporate loans back floating rate funds. And because these debts are first in line to be cleared in the case of a bankruptcy-led liquidity, the level of risk associated with investments in these are comparatively lower.

High Returns: Floating rate funds yield significantly more than the usual safe-haven investments, making them an appealing option for investors seeking a safer alternative to high-risk stocks while still earning higher returns than traditional safe-haven investments.

Who should invest in these funds?

Investors looking for lower risk options to earn a higher yield on their investments, since floater rate funds majorly invest in debt securities.

Investors looking to build a diverse portfolio of their investments which can compensate for the fluctuations in the rates.

The ones who can keep a tab on the market rates and can predict a rise in the interest rates, they can invest in these funds well in advance.

What are the best Floating Rate Mutual Funds to invest in 2021?

The White Ocean team has analysed the performance of various floater rate funds in the Indian markets and have come up with the top 3 performers among them. They are as below:

Aditya Birla Sun Life Floating Rate Fund – Long Term.
ICICI Prudential Floating Interest Fund
Nippon India Floating Rate Fund

Factors to keep in mind before investing

Always check the track record: Because floater funds are still relatively new, there isn’t a lot of data to analyse their performance over time. Before you invest, seek the advice of financial planners or advisors like White Ocean.

Always check their volatility: These funds have volatility since the yields they offer are linked to the economy’s current interest rates. As a result, their performance fluctuates and varies over time.

Balance of the portfolio: Because there are only a few floater securities available in the market, a floater fund’s portfolio could get concentrated towards a few such assets, which may raise concentration risk. Always choose a fund with a well-diversified portfolio.