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Floater funds: What they are and if you should invest?

Here's a short and simple explanation of floater funds and if they are a good investment option

Floater funds | Floater fund meaning | Floater debt fund

The floater debt fund category officially came into existence after SEBI's reclassification exercise. These funds predominantly invest in floating-rate bonds (at least 65 per cent), including fixed-rate bonds converted into floating-rate exposures by using derivative strategies.

Now since India has a limited market of floating-rate bonds, the majority of these funds use interest-rate swaps (exchange of interest rates between two parties) to artificially establish such exposures.

Characteristics of floating-rate bonds and how they differ from conventional bonds

  • Variable interest rate: Unlike traditional fixed-rate bonds, the interest rates of floating-rate bonds are periodically adjusted in line with rate changes in the economy.
  • Less volatile: Since floating-rate bonds have variable interest rates, they are less volatile and don't exhibit sudden fall in prices.

    That is why, the category of floater funds promise an advantage over funds which invest in fixed-rate bonds which can get adversely impacted during rising rates scenarios as there is a risk of a sudden drop in the price of the fixed-rate bond (classic inverse relation between interest rates and bond prices).

Even though we are in a rising rate environment, the category of floater debt funds has been witnessing outflows. You can read this story for more details.

Floater funds vs short-duration funds
While floater funds have a mandate on the type of underlying securities, short-duration funds have a mandate to maintain the portfolio duration between one year to three years. Thus, short-duration funds have reasonable flexibility to invest across debt and money market securities.

Given the current state of this segment in India in terms of liquidity concerns of floating-rate bonds, we believe these funds are not meant to be an investor's mainstream debt allocation. Moreover, short-duration funds are a more stable and versatile bet. Given their long-term record, they should be the core of your fixed income investments.

Suggested read: Floater funds losing sheen

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