It's not common to hear about floating rate funds when interest rates have been declining for so long. This is because any rate reduction causes bond yields to decline, which raises bond prices. Therefore, when rates are falling, bondholders and bond fund holders typically stand to gain significantly. However, while rates are increasing, the opposite is true. Bondholders and bond fund owners experience financial losses when rates rise because the bond's price declines. Investing in floating rate funds is one of the options available to investors.
What are floating rate funds?
Floating rate funds are a type of mutual fund that invests in debt securities whose interest rates fluctuate with changes in market interest rates. These funds are also commonly referred to as adjustable rate funds or variable rate funds.
Compared to typical fixed-income investments, floating rate funds are becoming a more and more popular option for investors hoping to both protect themselves against rising interest rates and perhaps increase their profits.
How do floating rate funds work?
Floating rate funds usually buy bank loans, also known as senior loans, which are debts given out by firms with lower credit ratings. Since this adjustment can be made quickly and easily, the yield on these floating rate bonds beats other types of bonds with fixed interest rates in a scenario where interest rates rise. Floating rate funds can only be profitable in an environment where yields are rising along with interest rates. Floating rate funds generally underperform other fund classes in the majority of other scenarios.
Since floating rate funds make investments in lower-grade bonds, they are not without risk. However, because bank loans are higher up on a company's debt list and have important support, these funds are viewed as less hazardous than high-yield bond funds.
Regulations of Sebi concerning floater funds
The sole requirement is that at least 65% of the fund must be allocated to either fixed-rate bonds converted into floating-rate bonds or floating-rate instruments.
Additionally, the limited number of instruments should meet the internal maturity, credit quality, and other standards set by the fund manager. This is how the fund managers abide by the regulation.
Floating Rate Funds vs. Liquid Funds
Bond fund investors have one more choice available to them. In periods when market yields are increasing, the liquid funds likewise raise their yields. The sole distinction is that, unlike with floating rate funds, there is a pause between each transaction. To manage rising rates, you can increase your exposure to liquid funds rather than investing in floating rate funds because liquid funds are already a component of your portfolio for liquidity. By doing this, you may be sure that your interest rate risk is virtually eliminated with the least amount of collateral portfolio damage. Naturally, while interest rates are rising, the yields on liquid funds are probably going to be lower than those on floating rate funds.
Conclusion
In conclusion, be sure you understand how these funds operate before you proceed.
When the RBI raises rates, funds in this category may have a one- to two-year investment horizon with a partial advantage. Contrary to what some people believe, this is not a miracle drug. Liquid funds and other money market funds are less volatile than floating rate funds when investing for less than a year.
To wrap it up, floating rate funds can be a valuable addition to a fixed-income portfolio for investors seeking protection against rising interest rates and the potential for higher returns. Yet, it's key to weigh the risks and benefits of these funds and talk to a financial expert to see if they fit your investment goals and risk level.
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