Floater Fund

A floater fund primarily consists of debt securities that offer variable returns based on market fluctuations or benchmark indices.
Floater Mutual Funds
4 mins
08-August-2024

A floater mutual fund is a type of debt fund that invests in bonds and securities whose interest rates change according to the market conditions. Unlike fixed income funds, which offer a fixed rate of return, floater funds offer a variable rate of return that is linked to a benchmark rate, such as the repo rate, Mumbai Interbank Offer Rate (MIBOR) or London InterBank Overnight Rate (LIBOR).

What is a floater mutual fund?

Floater mutual funds are a type of debt fund. They invest at least 65% of their money in floating-rate bonds, which are bonds whose interest payments fluctuate based on the current interest rates in the economy. It must be noted that the interest rates on these bonds change periodically to align with the prevailing market rates.

Now, for more clarity, let’s see some major advantages of floater funds:

  • These funds are a good investment choice when interest rates are expected to rise. That’s because when interest rates go up, the interest payments on floating-rate bonds also increase. This leads to higher returns for investors.
  • Most floater funds lend for short durations. This makes them relatively safer compared to other types of debt funds that lend for longer periods.
  • Investors looking for more predictable returns choose “liquid” or “ultra-short duration funds” within the floater fund category. These funds offer stable returns with minimal risk.

List of floater mutual fund schemes sorted by returns

How does a floater fund work?

Floater funds primarily invest in floating-rate instruments. These instruments have interest rates that adjust periodically based on changes in market interest rates. This implies returns from these instruments fluctuate with the market or benchmark indexes. Usually, investors of these funds get better returns when rates rise.

It is worth mentioning that floater funds also include certain fixed-rate instruments that are re-adjusted to behave like floating-rate instruments. This adjustment ensures that a large portion of the fund’s investments will respond to changes in interest rates. Now, when interest rates go up, the returns on these modified instruments can also increase, just like true floating-rate instruments. By doing this, floater funds take advantage of different phases of the business cycle.

Features of floater funds

  • Floater funds are moderate-risk funds, as they are less affected by the changes in the interest rate scenario. They can protect the investors from the risk of capital erosion due to rising interest rates.
  • Floater funds are short-term funds, as they invest in securities with a low maturity period, usually less than one year. They can provide liquidity and stability to the investors who want to park their money for a short duration.
  • Floater funds are dynamic funds, as they adjust their portfolio according to the market movements. They can increase or decrease their exposure to floating rate securities depending on the interest rate outlook.
  • Floater funds are tax-efficient funds, as they are treated as debt funds for taxation purposes. They are subject to a short-term capital gains taxable as per the slab rate if held for less than three years, and a long-term capital gains tax of 20% with indexation if held for more than three years.
  • Floater funds are diversified funds, as they invest in a variety of securities, such as corporate bonds, government securities, commercial papers, certificates of deposit, and treasury bills. They can reduce the credit risk and default risk of the portfolio.

What are the types of floater funds?

There are two main types of floater funds, based on the proportion of floating rate securities in their portfolio:

  • Pure floater funds: These are the funds that invest at least 65% of their assets in floating rate securities. They offer the highest sensitivity to the interest rate changes and the highest potential returns among the floater funds.
  • Hybrid floater funds: These are the funds that invest less than 65% of their assets in floating rate securities, and the rest in fixed rate securities. They offer a lower sensitivity to the interest rate changes and a lower potential return than the pure floater funds, but a higher stability and diversification.

Who should invest in floater funds?

Floater funds are suitable for investors who:

  • Have a low risk appetite and want to avoid the volatility of the equity market.
  • Have a short-term investment horizon and want to earn a regular income from their investments.
  • Have a positive outlook on the interest rate scenario and expect the interest rates to rise in the future.
  • Want to optimize their tax liability and benefit from the indexation benefit of the long-term capital gains tax.

When to invest in floater mutual funds?

The ideal time to invest in floater mutual funds is when interest rates in the country are rising. This mostly happens during periods of high inflation when the central bank implements a contractionary monetary policy, increasing the repo rates.

These increased repo rates lead to higher interest rates across the economy. Investing surplus funds in floater mutual funds during these times can be beneficial because the interest payments on the “floating-rate bonds” within the fund will also increase. As a result, these funds can generate substantial returns on your investment during these times.

How to invest in floater funds?

Investing in floater funds is easy and convenient. You can follow these steps to invest in floater funds:

  • Choose a fund: You can choose a floater fund that matches your risk profile, investment objective, and time horizon. You can compare the performance, portfolio, expense ratio, and ratings of different floater funds on various online platforms.
  • Open an account: You can open an account with the fund house or an online platform that offers floater funds. You will need to provide your KYC details, such as PAN, Aadhaar, bank account, and address proof.
  • Make a payment: You can make a payment through various modes, such as net banking, UPI, debit card, or cheque. You can invest in floater funds either as a lump sum or as a systematic investment plan (SIP).
  • Get a confirmation: You will get a confirmation of your investment through email or SMS. You will also get a statement of your account that shows the units allotted, NAV, and value of your investment.

Advantages of floater mutual funds

Floater mutual funds offer several advantages to the investors, such as:

  • Protection from interest rate risk: Floater funds can shield the investors from the adverse impact of rising interest rates, as they offer a higher return when the interest rates go up.
  • Liquidity and flexibility: Floater funds can provide liquidity and flexibility to the investors, as they can be redeemed at any time without any exit load or penalty.
  • Regular income: Floater funds can provide a regular income to the investors, as they pay dividends on a monthly, quarterly, or annual basis, depending on the availability of surplus. Plus, it is available only for dividend plans.
  • Low cost: Floater funds have a low expense ratio, as they do not incur high transaction costs or management fees.

Are you searching for the best mutual funds? Check out these different mutual fund categories for smart investing!

Limitations of floater funds

Floater funds also have some limitations that the investors should be aware of, such as:

  • Lower return than fixed income funds: Floater funds may offer a lower return than fixed income funds, especially when the interest rates are falling or stable.
  • Credit risk and default risk: Floater funds may face credit risk and default risk, if the issuers of the securities fail to pay the interest or principal amount on time.
  • Lack of awareness and availability: Floater funds are not very popular or widely available in the Indian market, as many investors are not aware of their features and benefits.

Floater mutual funds taxation

It must be noted that floater mutual funds are a type of debt fund. Now, after the latest changes proposed in the Union Budget 2024, when you sell these funds, the gains are always taxed at the applicable rates, regardless of the holding period. Also, there will be no indexation.

For a better understanding, let’s study an example:

Say you invest Rs. 1,00,000 in a floater mutual fund and sell it after two years for Rs. 1,20,000. This gain of Rs. 20,000 will be taxed based on your income tax slab. Now, let’s assume you also have income under the head salary of Rs. 10,00,000 and eligible deductions of Rs. 1,50,000 under Section 80C.

In this case, your tax computation (assuming the old regime) would be as follows:

Particulars

Amount

Income under head salary

Rs. 10,00,000

Add: Income under the head capital gains

Rs. 1,20,000

Gross taxable income

Rs. 11,20,000

Less: Deductions under Section 80C

Rs. 1,50,000

Net taxable income

Rs. 9,70,000


Now, the net taxable income of Rs. 9,70,000 will be taxed as per the slab rates applicable under the old regime.

Conclusion

Floater funds are attractive to many investors. They adjust their interest rates in response to changes in the market situations and repo rates. Also, they offer high liquidity and have a low risk of losing the initial investment. Hence, these funds are ideal for investors with a low-risk tolerance who want their principal amount to remain stable and not be affected by stock market volatility.

Moreover, investors looking to diversify their portfolios to reduce risk can also consider allocating a portion of their funds into floater funds. This diversification allows them to benefit from rising interest rates. That’s because floater funds provide substantial gains during periods of increasing interest rates. This makes them appealing to investors who want to profit from interest rate fluctuations. When investing in these funds, individuals should also consider the net asset value (NAV) of the funds.

When it comes to the optimal time to invest, you can choose floater funds when market interest rates are on the rise. Parking surplus funds in these investments during such times leads to significant capital gains, as the interest payments on the floating-rate instruments within the fund will increase.

However, before investing, make sure that the duration of the investment aligns with market predictions and your overall financial goals. This way, you can maximise your returns while maintaining low risk.

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Frequently asked questions

What is the duration of a floater fund?

The duration of a floater fund is the weighted average time until the interest rates of the securities in the fund reset.

Is it a good time to invest in floating rate funds?

It may be a good time to invest in floating rate funds if you expect the interest rates to rise in the future.

What is the maturity of a floater fund?

The maturity of a floater fund is the weighted average time until the principal repayment of the securities in the fund.

Are floating rate funds risky?

Floating rate funds are risky in terms of credit risk and default risk, as they may invest in low-rated or unrated securities.

How should you invest in a floater fund?

To invest in a floater fund, choose a reputable fund house and browse the different floater mutual fund schemes. Now, choose the scheme that fits your investment goals and risk tolerance.

Why should you invest in a floater fund?

Floater funds are less risky than equity investments. That is because they primarily invest in debt instruments. These funds provide substantial returns during rising interest rate periods in the form of capital gains or periodic dividend payouts. Also, they carry lower risk compared to equities, which makes them ideal for risk-averse investors.

What are the taxation rules for floater funds?

Floater funds are debt instruments. After the recent changes proposed in the Union Budget 2024, any gains arising from the sale of their units will be taxed as per the applicable rates, irrespective of the holding period. Also, there will be no indexation.

What is the risk level associated with floater funds?

Floater funds are generally low risk because they invest about 65% of their assets in debt securities. Also, in comparison to equity funds, they are less risky, which makes them suitable for risk-averse investors. However, be aware that returns can still be affected by fluctuating market interest rates.

What is the difference between short-term and long-term floater funds?

Short-term floater funds invest in securities with maturities of less than one year, such as treasury bills and certificates of deposit. On the other hand, long-term floater funds invest in instruments with longer maturities, like corporate bonds, government bonds, and debentures.

Can I redeem my investment in a floater fund anytime?

Yes, you can redeem your investment at any time in most floater funds, as they are open-ended. This implies you can withdraw your funds based on the current net asset value (NAV) which provides greater flexibility compared to closed-ended funds.

Are floater funds suitable for all types of investors?

Yes, floater funds are versatile investment options with flexible tenures and low risk. This makes them suitable for a wide range of investors. In most cases, they appeal to risk-averse individuals and those looking to benefit from fluctuating interest rates.

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Disclaimer

Bajaj Finance Limited (“BFL”) is an NBFC offering loans, deposits and third-party wealth management products.

The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. 

This information should not be relied upon as the sole basis for any investment decisions. Hence, User is advised to independently exercise diligence by verifying complete information, including by consulting independent financial experts, if any, and the investor shall be the sole owner of the decision taken, if any, about suitability of the same.