PremiumDSP Mutual Fund launched a floating rate fund on Thursday. The USP of such schemes is their ability to earn flexible interest rates depending on the prevailing rates in the economy. This positions them towards benefiting from a rising rate scenario, which typically causes mark-to-market losses in other types of debt MFs.
However, a low supply of floating-rate paper in India means that debt funds have to resort to interest rate swaps to become ‘floating rate’. These swaps trade a fixed rate for a floating rate with a counterparty. Other AMCs have taken a more cautious stance towards such funds.
“The idea behind launching this fund is to benefit from the yield-to-maturity (YTM) of a five-year maturity fund while hedging the risk of that kind of duration. The fund will invest only in sovereign bonds (issued by central and state governments). Corporate bonds simply aren’t giving enough premium on them. We estimate the YTM on the fund to be around 5% (basis current levels) and it will roll down from an effective maturity of 2 to 0 over a two-year period. After that, we will reset the maturity based on spreads as well as our interest rate outlook," said Saurabh Bhatia, head, fixed income, DSP MF.
Bhatia went on to explain how the interest rate swap will act as a hedge. “The interest rate swap brings down the fund’s average maturity to 2, which will eventually keep reducing every passing quarter. But the YTM is higher than what you would get in a two-year duration fund," he said.
The DSP Floating Rate Fund will benefit when the central bank withdraws liquidity from the system.
“This will create mark-to-market gains on the hedge, enabling lower mark-to-market losses on the underlying portfolio. This will get investors the best of both worlds," said Bhatia.
“There are not many actual floating rate bonds in India, thus the fund manager needs to be precise while executing interest rate swaps. Floater funds are not completely free from interest rate risk, but with the right maturity of the fund in the range of one to one-and-a-half years can help to reduce the mark-to-market hit quite a bit," said Rushabh Desai, a Mumbai-based mutual fund distributor.
Chetan Gill, a Chandigarh-based mutual fund distributor, added: “This fund is suitable for an investor who wants moderate returns, low credit risk and has a time horizon of two-three years. The fund’s expense ratio is also low, which makes it attractive."
