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There are two primary reasons for investments in Debt Funds. One of them is to complete your financial goal in a stipulated time frame. The other is to earn additional income. This depends on the interest rate that can be gained from Debt Mutual Fund investments and Bonds.
Debt Mutual Funds invest in a varying mix of bonds and securities, and of varying tenures as well. Bonds and securities have an inverse relationship with interest rates. When interest rates are up, bonds and securities yield lower returns and vice versa. Thus, the interest rate returns on a debt mutual fund depend on the supply and demand of credit. It depends on the monetary policy actions of the Reserve Bank of India, fiscal policies by the government, inflation, market fluctuations among other factors.
One such type of debt fund is the Floater Fund which primarily invests in bonds that have a floating interest rate. When bond prices go up and interest rates go down, investors tend to get higher returns and vice versa.
What is a Floater Fund
Debt instruments have either a fixed or a floating interest rate. Bonds generally have a fixed interest rate. This means when a bond matures, the investor receives the principal amount and a predetermined rate of interest on the principal amount.
Certain types of bonds have a floating interest rate. This would mean that the interest rate is not pre-decided and the changes depend upon their benchmark.
A fund that has more than 65% of its total assets invested in such bonds is defined as a Floating Rate Debt Fund or a Floater Fund. Instruments in Floater Funds can be corporate bonds or even loans from corporates that have a variable floating interest rate.
The returns generated on Floater Funds depend on the changing interest rates. However, every instrument can have a specific benchmark. Changes in the repo rate by the Reserve Bank of India affect the returns. Floater Funds rate of return increases as the market lending repo rate increases.
Features and Benefits of Floater Funds
- Portfolio: 65% of a Floater Fund corpus is invested in debt instruments that consist of fluctuating interest rates of government securities. The remaining part of the portfolio is invested in money market instruments or fixed-rate securities.
- Schemes: Floater Funds are open-ended schemes. This means that there is no restriction when it comes to trading. This means the fund manager can trade floating debt securities to maximize return. This is done keeping in mind the changing interest rate scenario and pending tenure of the asset held.
- Returns: The principal amount of the debt securities are considered to be generally secure. It is the interest rate that is variable. Investors can gain better returns when riding on fluctuating interest rates scenarios.
- Risks: The portfolio of Floater Funds consists majorly of debt instruments. The risk associated with these funds is considerably low when you compare them to equity instruments. This makes them an ideal investment tool for investors who have a low-risk appetite.
- Investment tenure: Floater Funds can be either short-term or long-term. Government securities that have a tenure of less than a year are short-term Floater Funds. These include treasury bills, certificates of deposits, etc. Long-term Floater Funds would consist of debentures, government bonds, etc.
Who Should Invest in Floater Funds
The returns gained from Floater Debt Funds move proportionately to current interest benchmark indices. Market conditions for this, depend on the changes in the repo rate as adjusted by the Reserve Bank of India. Hence, returns generated depend on these market changes.
When bond prices go up and interest rates go down, investors tend to get higher returns and vice versa.
For investors who wish for additional income apart from their fixed-income investments, Floater Funds can be a good choice. The rise and fall of interest rates will affect the returns on the investment. These funds also pose a credit risk as there are possibilities of default of the underlying security.
Before investing, investors should analyze the market economy. You have to remember that every time the economic situation of the country changes, you can expect a change in the interest rate. This can pose a positive as well as a negative factor on the investment. So if your returns are high during one period, they can also go down in another.
Investment needs to be in line with financial goals. Before investing in Floater Funds, you will need to ensure that your investments can match this aspect as well. Floater Funds can carry a bit of risk and you need to know your risk appetite.
Conclusion
With an investment corpus of 65% of total assets in floating rate instruments, Floater Funds are considered to be a relatively small category with limited funds. The changing interest rates may pose a risk for investors who want a fixed income through tenure. However, for investors who are willing to take a risk, Floater Funds can be a good investment.
Frequently Asked Questions (FAQs)
1. What are Floater Funds?
Debt funds that invest in instruments that have a floating rate of interest are defined as Floater Funds.
2. What are Floater Funds Linked to?
The interest rate of Floater Funds is linked to the benchmark indices or rates of the market and is reorganized at regular intervals.
3. What is the Best Time to Buy Floater Funds?
When interest rates are low and are expected to rise shortly is the best time to buy Floater Funds.
4. What kind of Interest does Floater Fund Generate?
On average, investors can expect returns between 5 to 7%. This is dependent on the benchmark interest rate indices of the market
5. How Much Tax do I Pay on Returns?
If the Floater Fund is liquidated before the end of 3 years, you are liable to pay short-term capital gain tax which is applicable as per the investor income tax slab. The gains on Floater Funds that have been held for more than 3 years attract long-term capital gain tax of 20% after accounting for indexation.
