One-Minute Guide: Floating rate fund

One-Minute Guide: Floating rate fund

Who am i

I invest in debt securities whose coupon rate fluctuates over a period of time. I derive my name from this quality.

What sets me apart from other debt funds

In case of fixed-rate securities, the yields (coupon rate as a percentage of the prevailing market price) fluctuate with market prices. If the market price goes up, the yields go down and vice-versa. These may give negative returns in a rising interest rate scenario.

On the other hand, a floating rate security—in which I invest—is designed to mitigate interest rate risk. It is benchmarked to an underlying security and the interest rate moves in the direction in which the rate of the underlying security moves. When the interest rates in the economy change, the prices of fixed-rate securities change as the underlying yields also change. A floating rate security will adjust its coupon rate accordingly and the prices will not change as much.

Where can i invest

As I mentioned earlier, I invest mainly in bonds (securities) that offer floating interest rate, but I am also allowed to invest a part of my corpus in regular fixed-return securities. The interest rates on these bonds are linked to a benchmark rate such as the Mumbai interbank offered rate, or Mibor, which is the average rate at which top banks borrow from each other overnight.

The interest rates on these bonds are reset periodically, sometimes within a day. Any rise or fall in the benchmark rate means an equivalent increase in the coupon rate.

Why am i unpopular

Compared with other debt schemes, investors generally avoid me because there aren’t too many floating rate scrips in India. Low investment opportunities have driven me to invest significantly in fixed-return scrips or create synthetic floaters such as investing in fixed-rate securities of a variety of tenors so what every few weeks some or the other security matures. New securities, therefore, make an entry into my portfolio at prevailing rates, which gives the impression that there is an interest-rate reset. These measures also contribute to poor returns.

I am not risk-free. When interest rates move, a floating rate instrument’s price fluctuates, too, though in a less volatile manner than fixed-income instruments. Lack of floating rate instruments, especially those with high credit rating, have made me somewhat directionless and many fund houses have modified my objective and turned me into plain-vanilla ultra short-term funds, also known as liquid plus