Floater funds back in focus as interest rates are all set to climb

They are best suited among the bouquet debt funds to sail through volatility in debt markets, say industry players

With inflation and yields on the benchmark 10-year government securities edging higher it is only a matter of time before the Reserve Bank of India (RBI) starts raising interest rates.

Given this backdrop, floater funds are the best suited among the bouquet debt funds to sail through the volatility in debt markets, say industry players.

During the past few months, floater funds have seen net outflows due to the tightening of liquidity and average returns. But now things could turn around.

The data from Association of Mutual Funds in India (Amfi) shows that in March floater funds saw net outflows of Rs 7,338 crore. In the last six months, the category has seen net outflows of about Rs 21,649 crore.  

Manish Banthia, senior fund manager-fixed income, ICICI Prudential AMC, says, “With the introduction of the standing deposit facility at 3.75 per cent liquidity adjustment facility corridor was restored at 50 basis points i.e back to pre-pandemic levels. We believe that due to the rising rate interest rate environment floating rate bonds may outperform all other fixed income instruments.”

Unlike normal fixed rate funds, floater funds invest a minimum of 65 per cent in floating rate securities issued by corporates or the government or convert fixed interest securities to floating via derivatives. A floating rate bond offers a coupon tied to a benchmark rate like the repo or the three-month T-bills. The coupon resets periodically to factor changes to the interest rates based on the movements in interest rates.

Typically, such funds are best suited in a rising interest rate situation and in 2021, floater funds were in demand as investors expected the RBI to increase the rates. But the central bank continued its accommodative stance to support economic growth.  

During the past one year, floater funds have given average returns of 3.93 per cent, lower than short duration funds and medium duration funds. “We have increased our exposure towards floating rate bonds in most of our schemes which bodes well in a rising interest rate cycle. Effectively the interest rate hike cycle has started, and we expect 100 basis repo rate hike in calendar year 2022,” added Banthia.

Market participants say that given the current scenario, rates might be hiked in the next few months and investors can look at floater funds, short-term bond funds and medium duration funds in their portfolio.