Do you think that this is the right time to shift away from normal debt funds to funds that invest in floating rate instruments?
R.C. Monga
It may well be, but you will know for sure only in the future. And no, that's not a joke. As the legendary investor Warren Buffet once said, "I have no idea about GDP growth, interest rates and the stock markets one year from now." Similarly, in mutual fund investing, it is not possible to ever know if it is the right time to invest, redeem, switch over or for any other action. We can only tell you the benefits and disadvantages of different types of funds and what one should broadly expect from them.
A floating rate fund is designed to take the sting out of rising interest rates. As interest rates rise, freshly issued bonds become more attractive. At the same time, older bonds see their value fall and therefore an existing portfolio of debt funds (which earns fixed interest rates) may see its returns decline in a period of rising interest rates.
Floating rate funds—or floaters, as they are sometimes called—invest in instruments whose interest rate keeps changing according to market conditions. Thus, the NAV of these funds does not react much to interest rate changes and has very low volatility. These characteristics make floaters attractive in situations when interest rates are expected to rise.
So whether its time to shift to floating rate funds or not depends entirely on how one expects interest rates in the Indian economy to behave. Certainly, interest rates have fallen so much in recent years that there may not be too much room for further falls. Indeed, they could even rise. After many years, we are in a situation when interest rates could rise, or fall, or stay stable, or become volatile around current levels. In many ways, this situation is tailor-made for floaters. You could well apportion some part of your portfolio to floaters as a safety belt.
This article was originally published on October 21, 2003.
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