INDIAN MUTUAL FUNDS

Floating rate funds: A good buy in rising interest rate scenario

What is a floating rate fund? These are the debt mutual funds which invests about 75% to 100% in securities which pay a floating rate interest (bank loans, bonds and other debt securities) while the rest is in fixed income securities. The primary advantage of these funds is that they are less volatile than other types of debt funds. This advantage arises due to the inherent structure of the floating rate bonds.

Floating rate funds vary from conventional fixed rate investments mainly on the basis of coupon rate i.e. the coupon is revised at regular intervals (i.e. floating) with respect to change in the benchmark rate. Consequently, if there is a rise in the interest rate, the coupon rate usually reflects this change, thereby securing the interests of investors during rising interest rates. Usually investors turn to these funds when they look for safety for their investments.

Interest rates have been rather unpredictable and specifically, they have been on the rise in recent times. Crude prices have risen and so has the inflation. The Reserve Bank of India (RBI) raised the repo rate by 25 basis points (bps) to 6.75% recently. With the volatility in government securities/bond prices over the last few weeks, investors seek safe haven for their investments in floating rate funds.


Many investors perceived income and gilt funds as "very safe" investments providing steady returns. However, it is only increasing volatility in the bond market which highlights the risk of investing in debt funds. Considering the fact that not a single long term floating rate fund has slipped into the negative terrain suggests that the performance of the floating rate funds have been quite good. Investors looking for capital preservation during times of rising interest rates cannot afford to ignore floating rate investments. However, they must note that while floating rate funds do well in a rising interest rate scenario, when the scenario turns (i.e. interest rates fall), floating rate funds underperform their fixed rate counterparts. So it's advisable to have a debt fund portfolio with adequate allocation for various categories so that investors are well placed to benefit from various phases of the interest rate cycle.
  source: (www.mutualfundsindia.com/mfi_14062011.asp.com)