What are the benefits and risks of floater funds?

Floater funds are a type of mutual fund that have gained popularity recently. Many investors find floater funds attractive because they offer the potential for good returns with moderate risk. Let’s take a closer look at what floater funds are, how they work, their benefits and risks, and why they may be a suitable investment option.

• Table of contents

1. What are floater funds?
2. How do floater funds work?
3. Benefits of floater funds
4. Risks associated with floater funds

What are floater funds?

Floater funds are a type of mutual fund that invests mainly in floating rate debt instruments. These are financial products where the interest rate can change. Unlike fixed-rate instruments where the interest rate stays the same, floating rate instruments have rates that go up or down based on market conditions.

How do floater funds work?

Floater funds invest in debt securities that offer varying interest rates depending on prevailing market conditions. The interest rates on these securities adjust periodically, usually based on benchmark rates such as Mumbai Inter Bank Overnight Rate (MIBOR) or Repo Rate. When interest rates rise, the returns from floater funds also tend to increase. On the other hand, if interest rates fall, the returns may decrease. This makes floater funds more flexible and responsive to changes in the interest rate environment.

Benefits of floater funds

• Reduced impact of rising interest rates: One of the biggest benefits of floater funds is their ability to minimise any impact on investors when interest rates rise. Fixed-rate bonds lose value when interest rates go up, but floating-rate bonds adjust and can offer higher returns.
• Potential for higher returns: Because floater funds invest in instruments that can increase their interest rates, they have the potential to provide better returns in a rising interest rate scenario.
• Diversification: Floater funds add diversity to an investment portfolio. They offer a different risk and return profile compared to equity funds or fixed-rate debt funds.
• Lower interest rate risk: These funds are less sensitive to interest rate changes than fixed-rate funds. This makes them a stable choice for investors looking to minimise interest rate risk.

Risks associated with floater funds

• Interest rate decline: If interest rates fall, the returns on floater funds can also decrease. This is the opposite of what happens when interest rates rise.
• Credit risk: Floater funds invest in debt instruments, which come with credit risk. If the issuer of a bond defaults, it can affect the fund’s returns.
• Market risk: Like all mutual funds, floater funds are subject to market risk. Economic changes, political events, and other factors can affect the performance of the underlying securities.
• Lower returns in stable rate environments: When interest rates are stable and not rising, floater funds might offer lower returns compared to fixed-rate funds.

Conclusion

Floater funds can be a good investment option for those looking to manage interest rate risk while still seeking decent returns. They offer mitigation against rising interest rates and can diversify an investment portfolio. However, they also come with risks, such as potential declines in returns if interest rates fall. Understanding these floater fund benefits and risks can help investors make informed decisions about whether these funds are the right choice for them.

FAQs

What are floater funds and how do they differ from other types of mutual funds?
Floater funds are mutual funds that invest in floating rate debt instruments. Unlike fixed-rate mutual funds, floater funds have variable interest rates that adjust with market changes, offering limited impact against rising interest rates.

Who should consider investing in floater funds?
Floater funds can be suitable for investors who want to minimise interest rate risk.

How do floater funds manage interest rate risk?
Floater funds manage interest rate risk by investing in floating rate instruments, whose interest rates adjust with market conditions. This means they can offer relatively higher returns when interest rates rise, unlike fixed-rate instruments which lose value.

Can floater funds provide stable returns over the long term?
Floater funds can provide relatively stable returns in a rising interest rate environment. However, if interest rates fall or remain stable, the returns may be lower compared to fixed-rate funds.

How liquid are investments in floater funds?
Floater funds are generally liquid investments, meaning investors can buy or sell their units on any business day. Redemption payout time period is similar to other debt funds. This makes them a flexible option for those who may need access to their money.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.