Floater, Liquid & Dynamic Funds

What are floater, liquid and dynamic bond funds? Please provide a comparative performance of each? And among these which is the least risk product?

Ankur Gupta & Nitin Gandhi

Floaters or Floating Rate funds invest between 65-100 per cent of their assets in floating rate instruments and the rest in fixed-income instruments. The interest rate on floating rate instruments is re-adjusted periodically according to the existing reference market interest rate. Thus, these instruments are less susceptible to the interest rate risk as compared to fixed-income products. Floating rate funds are a good substitute to income funds, when interest rates are expected to rise because even though the price of the fixed-income securities would fall you would benefit from periodically readjusted higher coupons.

Liquid funds or Cash funds invest in low maturity bonds and money market instruments like commercial papers, short-term treasury papers and bank deposits. These instruments are on the lowest end of the risk-return continuum, hence returns are also on the lower side. It is basically ideal for parking short-term surpluses.

Dynamic bond funds are those funds, which have the liberty to invest in a range of debt and money market instruments across various maturities. In bad times, they could also hold a majority of their assets in cash. But, the whole dynamism lies with the fund manger and is not linked to any market indicator. Currently six Indian AMCs have Dynamic Bond funds.

In the past six months, floating rate funds and liquid funds have delivered almost same returns (2.2 and 2.13 per cent, respectively). The story is more or less the same over the three-month period. On the other hand, dynamic bond funds have yielded a pathetic 0.55 per cent return in the past six months. Since dynamic bond funds are actively managed, there is a vast difference in the returns of best and worst dynamic bond funds. For example, while Tata Dynamic Bond gained 1.6 per cent, Deutsche Dynamic lost 1.1 per cent in the same period.

As stated earlier, liquid funds are for short-term investments and hence lie on the low risk-return platform. Quick redemption and no entry-exit load are its major advantage. Then come the floating rate funds which are a good investment avenue especially in the present scenario of rising bond yields. Cautious investors would find it appealing, even as a long-term investment. Dynamic bond funds are the riskiest of the three as the returns are totally dependent on the fund manager's interest rate expectations. However, while one's mind naturally focuses on risk in the current bleak environment, the fact is that over an extended period, a well-managed dynamic fund should certainly give higher returns than liquid or floating rate funds.

This article was originally published on July 28, 2004.