Can you explain how exactly floating rate bond funds work? Are they safer than income funds and how?
Hiren Trivedi
Floating rate funds usually invest 65-100 per cent of their assets in floating rate instruments and the rest in fixed-income instruments. On the other hand, income funds generally have a 100 per cent portfolio of fixed-income instruments, even though nothing prevents them from investing in floaters.
Generally, the price of fixed-income instrument changes in accordance to changes in the interest rate -- Bond price falls, when interest rates rise and vice-versa. But in floating rate instruments, the interest rate is re-adjusted periodically in keeping with prevailing market interest rates. Thus, the impact of change in interest rate on price of floating rate bond is minimal as compared to fixed-income instruments. This makes floating rate funds less volatile vis-à-vis income funds.
The past six months have conclusively proven the worth of floating rate funds for risk-averse investors. In these six months, floating rate funds have delivered a return of 2.19 per cent as on July 2, 2004 as compared to a negative 0.05 per cent return delivered by the income funds.
Unlike income funds, floating rate funds' return has been very consistent. For instance, during the volatile months of January and February 2004, income fund's return went into negative, whereas floating rate funds' returns remained unaffected. This was also the case in the last year's bad months of January, March and November. The category's consistent performance in these volatile times has polished floating rate fund's image as one of the most stable debt products around.
Floating Rate fund is a new concept in India. Franklin Templeton mutual fund was the first fund house to launch Floating Rate funds in India in February 2002. But with increasing volatility in the debt market, the number of such funds has gone up to 18 now. The year 2003 alone saw the launch of 15 such funds. The government of India has also started issuing floating rate sovereign debt recently, which is expected to give a major impetus to the pace of development of floating rate market in India.
This article was originally published on July 05, 2004.
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