Risks and returns associated with floating rate mutual funds

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Risk and returns are two sides of the same coin called ‘investment’. The risk-return profile of any investment should be appropriately assessed before investing in the same. Here, we discuss the risk and returns associated with floater funds. Before we do so, we need to understand the nuances of these funds.

Floating rate funds – definition and features:

Floating rate mutual funds are debt mutual funds which invest at least 65% of the underlying funds in debt securities with floating interest rates. The balance can be invested in fixed-income securities. The returns from these funds tend to ‘float’ as per the interest rate cycle. If the interest rate cycle is rising, then the floating rate funds may show a corresponding increase in returns as well.

Floater funds leverage the interest rate cycle and aim to enhance their returns during the rising interest rate scenario. These funds are not devoid of risk factors, therefore we must understand the risk factors and invest in an informed manner.

Interest rate and returns:
The returns of floater funds are governed by the prevailing interest rates. If the RBI increases interest rates, the returns from floating rate funds might also increase. Hence a rise in interest rates is a positive sign for floater funds. On the contrary, other category debt funds such as bond funds, and gilt funds which have fixed income instruments as underlying assets could lose value since their interest rates will not rise.

How should you choose a suitable floater fund?
Choosing a floating rate fund can be guided by the following factors:

  • Credit risk
    The credit quality of the underlying instruments is critical for the funds’ performance. Whilst investing in floater funds, remember to check the credit quality of underlying instruments. Investing in AAA and AA+ debt instruments could reduce the credit risk.

    Credit risk refers to the default risk which may arise in the event of a lapse in payment as per schedule by the bond issuer. In such events, the fund is likely to suffer an unprecedented setback. This is also one of the most prominent risks associated with debt instruments.

  • Tenure of investment
    Floating rate mutual funds may be suitable for investors with an investment horizon of 6 months – 3 years. It may also be a suitable avenue to park your emergency funds, especially during a rising interest rate scenario.

Based on the above considerations, you should now be able to invest in floater funds to generate potential returns with relatively lower risk.

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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