What are floating rate funds?

Floating rate funds are a category of fixed-income mutual funds that invest primarily in debt instruments with floating interest rates. Unlike traditional fixed-income securities, where interest rates remain constant over the investment period, the interest rate in floating-rate instruments is reset periodically based on a benchmark, such as the repo rate. This helps mitigate some of the risks associated with fixed-income investments.

Features of Floating Rate Funds

Understanding the key features of floating rate funds can help investors assess whether they align with their financial goals and risk tolerance. Some of the key features are mentioned below:

According to the definition of floating rate funds and its categorisation by SEBI, such a fund must invest 65% of its assets in floating rate instruments. Such funds combine the potential stability of fixed-income securities with the flexibility to adapt to changing interest rate environments. Here are some of their features:

• Dynamic interest rate: Bond prices in the market are inversely proportionate to the interest rate, which is what contributes to the risks involved in debt investments. The variable interest rate of the securities included in floating rate funds can make them relatively resilient to interest rate fluctuations.
• As interest rates rise in the economy, the coupon rates of floating rate securities increase. This can mitigate the impact of rising interest rates on the fund's Net Asset Value (NAV).
• Portfolio diversification: Maintaining a diversified portfolio is a key investment strategy with floating rate funds, meaning that they invest in floating rate bonds, floating rate notes, treasury bills, and other money market instruments.
• Lower interest rate risk: Floating rate funds are less vulnerable to interest rate risk compared to traditional fixed-income funds. Since the coupon rates of floating rate securities reset periodically, the principal value of the fund's investments is less sensitive to changes in interest rates.
• Income generation: They offer potential income generation opportunities for investors through regular coupon payments received from the underlying floating rate securities.

Factors to Consider Before Investing in Floating Rate Funds

Now that you know what floating rate funds are, you may be wondering if they are suitable for you. Here are a few factors you must keep in mind:

• Interest rate environment: Investors should assess the prevailing interest rate environment and macroeconomic conditions to determine the suitability of floating rate funds in their investment portfolios. Floating rate funds may underperform in a declining interest rate environment.
• Credit risk: Although floating rate funds primarily invest in high-quality, short-duration securities, they are not immune to credit risk. Investors should evaluate the credit quality of the underlying portfolio holdings to mitigate credit risk exposure.
• Investment horizon: Investors should align their investment horizon with the duration and maturity profile of floating rate funds. Investors with short-term investment horizons may prefer funds with greater liquidity and lower duration.

Conclusion

Floating rate funds, which invest predominantly in fixed-income instruments with a variable interest rate, can help mitigate some of the risks associated with the debt market. However, investors should consider the current interest rate environment and their investment horizon before choosing a scheme. It is advisable to consult a financial advisor before making investment decisions.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.