Floater Mutual Funds: Definition, Types and Benefits
We all have come across multiple debt mutual funds and it might bring new questions and doubts.
There are many types of debt mutual funds depending on their investment instruments. Floater mutual funds primarily invest in bonds and debt instruments that have floating or variable interest rates. Fluctuating interest rates in the market primarily determine the rate of interest of floating funds. This allows the fund to earn coupon income which is in sync with the current interest rates in the market.
Read on to learn how these debt funds work.
What Are Floater Funds?
According to SEBI (Securities Exchange Board of India), floater mutual funds are open-ended debt schemes that primarily invest in floating rate instruments. SEBI has mandated that the minimum investments in such instruments must be 65% of the fund’s total assets. A floating rate instrument has a variable coupon payment which means that the interest rate fluctuates based on the benchmark rate reset at regular intervals.
Hence, the current floating rates of the market govern the interest rate of a floater mutual fund. If RBI introduces any changes in the repo rate, it affects the returns of floater funds. There is a directly proportional relationship between the repo rate and the interest rate of floater funds. If the repo rate increases, a floater fund’s interest rate will also increase.
These mutual funds take advantage of fluctuating interest rates and generate higher returns for investors. Their portfolio comprises corporate bonds, certificates of deposits, T-bills and similar assets with a floating interest rate. In recent years, floater funds have generated annual returns ranging from 7% to 9%.
How Does a Floater Mutual Fund Work?
As mentioned before, floater funds invest in floating instruments. Every floating rate instrument has a specific benchmark. Fluctuations in the interest rate of their benchmarks determine the changes in the interest rates of these securities.
The interest rates of floater debt funds are kept in sync with the market periodically. This makes them an ideal low-risk investment when interest rates are supposed to go up.
According to AMFI (Association of Mutual Funds in India), floating rate securities are usually linked to Mumbai Interbank Offer Rate (MIBOR), which is the benchmark rate for debt instruments.
Different Types of Floater Mutual Funds
- Short-term floater funds
These floater funds invest in debt securities with short maturity periods and high liquidity. Examples include treasury bills, commercial papers, certificates of deposits, government securities etc.
- Long-term floater funds
These funds invest in debt securities with longer maturity periods. While a significant portion of the portfolio contains floating rate debt instruments, the fund manager invests the remaining portion in money-market instruments or fixed-rate securities.
Features of Floater Funds
- Open-ended scheme
People willing to invest in floater mutual funds can do so at any time of the year as per their convenience and financial objectives. Furthermore, people can exit the funds easily if they feel it is no longer beneficial. You can decide the entry and exit based on your needs, financial goals and investment purpose.
- Diversified portfolio
Floater funds invest in both floating rate instruments as well as some fixed income securities. This provides diversification to your debt portfolio thus reducing the overall risk of your portfolio.
- Lower risk
Risks associated with floater funds are less compared to equity funds, but there are risks. There remains a risk of default of underlying securities. Furthermore, the repo rate impacting the interest rate of the floating rate instruments are in the hands of the RBI and changes with the economic condition of the country, leading to unpredictability, but investments in high-rated funds and securities may help to mitigate these risks.
- Reasonable returns
Floater mutual funds deliver high returns when the interest rate movements are favourable. Their allocation to fixed-income securities ensures risk mitigation in low-interest rate regimes. In the long run, these funds have been seen to generate higher returns than some debt instruments and fixed deposits.
- Unpredictable Returns
Any change in the repo rate by RBI affects the rate of bonds, government securities and other debt instruments. An increase in repo rate means an increase in the rate of these debt instruments, consequently increasing the yield of the floater fund. Due to these fluctuations, the returns of floater funds cannot be anticipated in advance. Therefore, the risk associated with the interest rate for floating rate instruments is uncertain.
Who Can Invest in Floater Debt Funds?
- Risk-averse investors can consider floater mutual funds because these funds majorly invest in debt securities.
- People who wish for a diversified portfolio and diluted risk can choose this particular investment option.
- Investors wishing to compensate for high-risk investments in their portfolio may consider investing in floater mutual funds.
- These mutual funds are also suitable for people who are willing to study and analyse the market well before making an investment decision.
Taxation of Floater Mutual Funds
Floater mutual funds fall under the category of debt mutual funds. So, their taxation is similar to debt funds.
- If an investor holds these mutual fund units for less than three years, the profits are considered STCG or Short Term Capital Gains. These are added to an investor’s income and taxed according to his or her income tax slab rate.
- If the holding period of the investment exceeds three years, then the profits are seen as LTCG or Long Term Capital Gains. The applicable tax rate is 20% with indexation benefits.
List of the Top Floater Mutual Funds in 2022
The table below lists the top floater mutual funds in India in 2022 based on their 3-year annualised returns:
|Name of Floater Mutual Fund||3-Year Annualized Returns|
|Nippon India Floating Rate Fund- Direct Plan- Growth||6.70%|
|ICICI Prudential Floating Interest Fund- Direct Plan- Growth||6.88%|
|Kotak Floating Rate Fund- Direct Plan- Growth||6.53%|
|HDFC Floating Rate Debt Fund- Direct Plan- Growth||6.30%|
|Aditya Birla Sun Life Floating Rate Fund- Direct Plan- Growth||5.97%|
|UTI Floater Fund- Direct Plan- Growth||5.59%|
This blog has enumerated the details related to floater mutual funds. These are open-ended mutual fund schemes that primarily invest in floating rate instruments. Floater funds are of two types and have many benefits. Additionally, their taxation is similar to debt funds. A list of top floater funds in India has been provided for readers’ benefit.
FAQs about floating rate fund
What is the best time to invest in a floating rate fund?
An individual should invest in a floater mutual fund when they expect the interest rates in the debt market to rise. Additionally, when financial experts say that repo rates are set to increase in India, investors should use the opportunity to invest in floater funds.
Does a floater mutual fund invest in fixed income securities?
Yes. As per the guidelines, floater funds need to invest a minimum of 65% in floating rate securities. The fund manager usually invests the remaining portion of the fund in fixed-income securities.
What are the limitations of floater mutual funds?
Limitations of floater mutual funds are given below:
> High volatility compared to fixed income funds is a major limitation. Therefore, the performance of these funds is entirely dependent on prevailing market conditions.
> An investor must take into account the credit risk associated with floater funds.
Why do floater debt funds use index swaps?
Since the floating rate bond market size is not large enough in India, Mutual Fund Companies use derivative instruments like Overnight Index Swaps to convert the fixed coupon yielding portfolio into a floating rate portfolio.