A floater fund is a type of debt mutual fund that primarily invests in floating-rate instruments, where the interest rate fluctuates based on market conditions. Unlike fixed-income funds, which invest in bonds with a predetermined interest rate, floater funds benefit from rising interest rates as their returns adjust accordingly. These funds allocate at least 65% of their portfolio to floating-rate securities, including government bonds, corporate debt, and money market instruments. The key advantage of floater funds is their ability to provide stable returns in a dynamic interest rate environment. Investors seeking protection against interest rate volatility often prefer these funds as they adjust to market fluctuations, reducing the risk associated with fixed-rate instruments. Floater funds are well-suited for investors who want to capitalise on increasing interest rates while maintaining relatively low risk. In India, these funds are regulated by the Securities and Exchange Board of India (SEBI) and are offered by various asset management companies (AMCs).
How do floater funds work?
Floater funds function by investing in bonds and debt instruments with variable interest rates. These funds primarily hold floating-rate securities, which means their interest payments fluctuate based on market benchmarks such as the Reserve Bank of India’s (RBI) repo rate or the Mumbai Interbank Offered Rate (MIBOR).
When interest rates rise, the yields on floating-rate bonds increase, leading to higher returns for investors. Conversely, if interest rates fall, the interest payments decrease, which may impact returns. However, since floater funds are actively managed, fund managers adjust the portfolio to mitigate risks associated with declining interest rates.
These funds offer an advantage over traditional fixed-income funds, as their returns are not locked at a predetermined rate. By dynamically responding to changes in the economy, floater funds provide investors with a flexible investment option. In India, financial institutions and mutual fund houses manage these funds, ensuring they align with market conditions and investor objectives. Floater funds are particularly beneficial in an environment of rising interest rates, as they offer better risk-adjusted returns than conventional debt funds.
Benefits of investing in floater funds
Floater funds offer several advantages, making them a preferred choice for investors seeking flexibility and stable returns.
Interest rate adaptability – Floater funds adjust to market interest rate fluctuations, offering better returns in a rising rate environment.
Lower risk compared to fixed-income funds – Since floater funds are not locked into a fixed rate, they reduce the risk of capital loss during interest rate hikes.
Stable returns – While market fluctuations affect returns, floater funds offer relatively stable performance compared to equity investments.
Liquidity – Most floater funds offer high liquidity, allowing investors to redeem their investments when needed.
Diversification – These funds invest in a range of debt securities, reducing overall risk.
Tax efficiency – Floater funds held for the long term can provide tax benefits under capital gains taxation.
Professional management – Experienced fund managers optimise portfolios to maximise returns while minimising risks.
Risks associated with floater funds
Although floater funds provide many benefits, they also come with certain risks that investors should be aware of.
Interest rate risk – While floater funds benefit from rising interest rates, a sharp decline in rates can lower returns.
Credit risk – Some floater funds invest in corporate bonds, which may carry the risk of default by issuers.
Liquidity risk – If a fund invests in low-rated debt securities, it may face liquidity constraints during market downturns.
Market volatility – The performance of floater funds depends on economic conditions, making them susceptible to short-term fluctuations.
Management risk – The success of a floater fund depends on the expertise of the fund manager, who must make timely adjustments to optimise returns.
Taxation risk – Short-term gains from floater funds may be subject to higher taxation, impacting overall profitability.
Types of floater funds
Floater funds come in different categories based on their investment strategies and risk exposure.
Short-term floater funds – These funds invest in short-duration floating-rate bonds, making them ideal for investors with a short investment horizon.
Long-term floater funds – These funds focus on long-duration floating-rate securities, providing higher returns over an extended period.
Government floater funds – These invest primarily in government-issued floating-rate bonds, offering low credit risk.
Corporate floater funds – These funds allocate a significant portion of their assets to corporate bonds with floating interest rates.
Hybrid floater funds – A mix of floating and fixed-rate instruments, these funds aim to balance risk and return.
Who should invest in floater funds?
Floater funds are suitable for investors looking for stable returns with lower risk than equity investments. They are ideal for individuals who expect interest rates to rise and want to capitalise on increasing bond yields. Investors with a moderate risk appetite and a short- to medium-term investment horizon can benefit from these funds. Corporate investors and institutional investors also use floater funds to manage liquidity while earning reasonable returns. Additionally, those looking for alternatives to fixed deposits and other debt instruments may find floater funds a viable option due to their flexibility and market responsiveness.
How to invest in floater funds?
Investing in floater funds is straightforward and can be done through various financial platforms. Investors can purchase units directly from asset management companies (AMCs), mutual fund distributors, or online investment portals. Before investing, it is important to evaluate factors such as fund performance, expense ratios, and risk levels. Investors should also consider their financial goals, investment horizon, and market conditions before selecting a floater fund. Since floater funds respond to interest rate changes, keeping track of economic trends and monetary policies can help optimise returns.
