How Floating Rate Debt Mutual Funds Reduce Interest Rate Risk?

Debt Funds are the preferred investment route for conservative investors. But every smart investor knows that even this category comes with its own risks. One of them being interest rate risks. But what if we were to tell you that there are options within the debt fund category that can reduce this risk to a significant extent? Yes, we are talking about Floating Rate Funds. If you want to optimize your debt fund investments and minimize the risks involved, continue reading.

Meaning of Floating Rate Funds

Floating Rate (or Floater) Funds are a type of debt fund. These open-ended debt schemes predominantly invest in floating rate instruments. As per the SEBI guidelines, they need to maintain a minimum investment of 65% (of their total assets) in floating rate instruments.

These funds seek to offer investors a source of flexible income and capitalize on rising interest rates scenarios. Floater Funds returns depend heavily on the overall market conditions and policy changes such as changes made in Repo Rate by RBI.

Floating Rate Fund Advantages

  • Minimised Interest Rate Risk

One of the most important floating rate fund advantages is its ability to bring down interest rate risk associated with debt investments. Interest Rate Risk refers to the potential loss or a depreciation in investment value, as a result of interest rate changes. Bond prices and interest rate movements share an inverse relationship. One goes up, the other goes down. This factor increases the risk in debt fund investments.

However, in case of floating rate funds, the coupon or interest rate is fluctuating and gets reset on a periodic basis. They move in tandem with the prevalent interest rates. As a result, you can hedge effectively against interest rate risk by investing in these funds. These funds give a block-buster performance when the interest rates are on a rise.

  • Relatively less credit risk

Another category of risks that plagues debt funds is credit risk. It is the risk of default on the part of the borrower (bond issuer) to repay principal amount or pay the interest thereon. Floater Funds carry lesser credit risk as compared to some other debt fund variants such as dynamic bond or credit risk funds. The credit risk in floater funds can be circumvented by choosing a scheme that invest in instruments with high credit rating.

  • Yield Potential

Floater Funds have the potential to generate superior returns than investment avenues such as Fixed Deposits and other debt fund variants.

This category generated 8.66% in the one-year timeframe, while the three-year returns are 7.35%.

Year-wise performance

YearReturns
20176.52%
20186.74%
20198.39%

One of the top floating rate funds (Nippon India Floating Rate Fund) generated double-digit returns (10.13%) in the last year.

  • Tax benefits

Floater Funds get the benefit of indexation when they are held for a minimum period of three years. Indexation helps bring down your tax liabilities as it accounts for inflation. The long-term capital gains tax for floater funds is 20% with the benefit of indexation.

Top Floating Rate Funds in India

If you are looking for the best performing funds from this category, look no further. Here are the top floating rate funds in India:

  • Nippon India Floating Rate Fund
  • ICICI Prudential Floating Interest Fund
  • Aditya Birla Sun Life Floating Rate Fund
  • HDFC Floating Rate Debt Fund
  • Franklin India Floating Rate Fund
  • Kotak Floating Rate Fund

Final Words

The numerous floating rate fund advantages make them apt for conservative investors as well as those who want to dilute their portfolio’s risk. For risk-loving investors floater funds are the perfect vehicle to balance out their aggressive investment strategies, especially during times of fluctuations. 

Published by Nidhi Mehra

I am blogger with 5 years of experience in writing articles and topics related to finance and funds

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