Sailing through floater funds in a scenario of rising interest rates

Floater funds have given returns of over 5 per cent in the last one year

During the past few months, floater funds have seen traction from the investors as well as the fund houses. The demand has risen for these funds as they are best suited to ride through during the rising interest rate environment.

During the past one-year floater funds have on an average given returns of 5.11 per cent, higher than other categories like short-duration fund, dynamic bond fund and banking and PSU funds, among others.

Market participants say that currently the economy is at the bottom of the interest rate cycle, as the Reserve Bank of India (RBI) is likely to roll back accommodative monetary policy.  The rise in interest rates in turn would help floater funds generate better risk adjusted returns.

During the recently launched Axis Floater Fund, Chandresh Nigam, MD & CEO, Axis AMC, said “The economic fundamentals are improving gradually and returning to normalcy. The country is also likely at the bottom of the interest rate cycle, and we expect rates to see a gradual rate hike cycle in the medium term. With the launch of this fund, we believe that we will provide an efficient solution for short-term investors looking to navigate a possible rising rate environment.”

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.

“The reset of coupon to higher interest rate makes the floating rate bond more valuable than fixed rate bond in a rising interest rate environment where the fixed rate bond value falls as rates rise,” said a fund manager of a leading fund house.  The floating rate strategies aim to manage interest rate risks by investing in bonds where the coupon is linked to market movements.

In the last few months floater rate funds have been getting sustained net inflows. The data from Association of Mutual Funds in India (AMFI) shows that floater funds have received net inflows of around Rs 9,800 crore in the last three months.

However, there are certain risks attached to such schemes as availability of floating rate instruments is quite limited in India. Joydeep Sen, Corporate Trainer-Debt says, if we look at the portfolios of floating rate funds, the component of floating rate papers is on the lower side, say less than 50 per cent and investors should understand the product and its strategy before investing into it.