Floater funds losing sheen

Aggressive rate hikes have derailed their playbook

Floater funds losing sheen

Lights have blown out on the very funds that promised higher returns during a rising interest rate cycle.

Known as floater funds, this category witnessed a net inflow of Rs 67,952.74 crore between April 2020 and October 2021. Fund houses, which were aggressively marketing these funds at the time, painted this scenario: floater funds are positioned to benefit from a rising rate cycle. (And since rates were at multi-year lows in 2020 and 2021 due to the pandemic, several investors parked their money in them.)

But 2022 didn't seem to have read the script. Sure, interest rates were increased to tame surging inflation, but floater funds were sucker-punched by the intensity of the hikes, delivering an anaemic 1.16 per cent returns between January and April this year- lower than liquid funds, overnight funds and low-duration funds.

"With such high-rate hikes in a short span of time, the floating rate funds start(ed) to lose their shine. Floater funds make sense when there is uncertainty in the quantum of rate hikes, inflation and macroeconomics," Devang Shah, co-head of fixed income at Axis Mutual Fund, said.

Unsurprisingly, investors are pulling their money from floater funds. The category has seen an outflow of Rs 32,882.01 crore this year - almost half the money they had invested in the good days of April 2020 to October 2021.

Explaining how higher-than-expected rate hikes dimmed floater funds' performance, Shah said: "Central banks did a front-loading of rate hikes and squeezed banking liquidity." This led to "significant re-pricing" of all bonds, both short- and long-term.

Shah also cited other forces at play: "Everything changed after the Russia-Ukraine crisis. Inflation surged, along with commodity and crude prices."

To counter inflation, India's central bank interest has so far upped its rates by 140 basis points (1.4 per cent) in 2022.

What now
Floater funds were positioned to benefit from the rising rate playbook, but sharp front-loading of rates spoiled their game.

Going forward, market participants are not expecting any major interest rate hikes, and floater fund as a category is unlikely to gain much traction any time soon.

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