Is investing in floater funds right for you?

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Have you been scouting for a relatively low-risk investment option with the potential to yield returns? Then you may want to consider floater funds which could provide considerable returns commensurate with the market interest rates. Read on to know how floater funds could be suitable for your investment portfolio.

What are floater mutual funds?
They are a category of debt mutual funds available for investment. Some instruments that floater funds may invest in are T-bills, government securities, certificates of deposits etc.

How do floater funds work?
Floater funds are mandated to invest at least 65% of the underlying funds in floating rate instruments. Floater fund returns tend to ‘float’ with the interest rate. An increase in interest rate helps the floater funds to generate returns in correspondence to the rising interest rates.

When does it make sense to invest in floater funds?
The interest rate cycle is an important consideration whilst investing in floater funds. In case the RBI hikes the interest rates, it may result in floater fund returns also seeing a jump.

All the debt funds committed to fixed–income instruments like government securities and corporate bonds potentially lose value due to such a rise in interest rate. However, this could work favourably for floating rate funds. Hence, it might make sense to invest in floating-rate funds when the interest rates are in a rising phase.

What are the risks associated with floating rate funds?
Floater funds are within the debt mutual fund category; however, they are not devoid of risk. They continue to be exposed to credit risk and duration risk. Credit risk refers to the possibility of default in committed payments by the issuer of bonds. Duration risk is the risk of an unfavourable change in the interest rate which leads to a corresponding change in the market value of the fixed-income instrument.

Floating rate funds can hold up to 35% in debt and money market instruments other than floating rate instruments at any given point in time. A fall in interest rates is considered unfavourable for floater funds. However, floater funds as a category bear lower risk as compared to other avenues such as equity mutual funds, equity stocks etc.

Factors to evaluate
The choice of investing in floater funds should be guided by evaluating these factors:

  1. Taxability:
    If redeemed within 36 months, short term capital gain tax is applicable. This means the gains are taxed as per the investor’s income tax slabs. Long term capital gains on floater funds can avail the benefit of indexation which could lower the tax liability. If held for longer than 36 months, long term capital gains apply. This is a tax of 20% (excluding applicable surcharge and cess) with indexation benefit.
  2. Interest rate cycle:
    One of the foremost aspects to consider is the outlook toward interest rates. If we are in a rising interest rate period, then one could look at investing in floater funds.
  3. Potential for returns
    Floater funds tend to provide returns in line with the prevailing market interest rate. This can be beneficial in a rising interest rate scenario.
  4. Credit quality:
    The choice of floater funds should not only be based on the long term outperformance of the fund but should also be guided by the credit rating of instruments that underlie the fund.

Floater funds are a suitable way to diversify and bring down the overall risk of the portfolio in certain situations. Even a person with a relatively low risk appetite could consider investing in these funds, provided the interest rate cycle is favourable.

Disclaimer:-
An investor education initiative.

Visit www.icicipruamc.com/note to know more about the process to complete a one-time Know Your Customer (KYC) requirement to invest in Mutual Funds. Investors should only deal with registered Mutual Funds, details of which can be verified on the SEBI website https://www.sebi.gov.in/intermediaries.html. For any queries, complaints and grievance redressal, investors may reach out to the AMCs and / or Investor Relations Officers. Additionally, investors may also lodge complaints on https://scores.gov.in if they are unsatisfied with the resolutions given by AMCs. SCORES portal facilitates you to lodge your complaint online with SEBI and subsequently view its status.
Mutual fund investments are subject to market risks, read all scheme related documents carefully.

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