Floater Mutual Funds

What are Floater Funds?

Floater funds are a type of mutual fund wherein most of your money goes into floating-rate instruments. A floating rate implies that these interest rates are not fixed but fluctuate based on a benchmark rate (repo rate set by the RBI). Let's say the RBI issues a floating-rate bond with a coupon rate of repo rate + 0.5%. This means the bond's interest rate is directly linked to the repo rate set by the RBI, with an additional spread of 0.5%.

Suppose the current repo rate is 4%. In this case, the initial coupon rate of the floating rate bond would be:

Repo rate (4%) + Spread (0.5%) = 4.5%

Now, let's see how this bond's coupon rate would change if the RBI increases the repo rate to 5% to control inflation:

New Coupon Rate = New Repo Rate (5%) + Spread (0.5%) = 5.5%

As the repo rate increased by 1% (from 4% to 5%), the floating rate bond's coupon rate also increased by 1% (from 4.5% to 5.5%). This adjustment ensures that the bond's yield remains competitive with current market rates. So you’ll be at the profit with floating rate mutual funds. Learn more about this mutual fund here.

How Floater Funds Work?

The fundamental concept behind floater funds is that as interest rates rise, the yields on floating rate instruments adjust upwards, potentially offering better returns compared to fixed-rate bonds, which can suffer in a rising rate environment. Conversely, when interest rates fall, the returns on floater funds might not be as high as those on fixed-rate securities.

Here’s a simplified explanation of how floater funds work:

Floating rate instruments within the fund portfolio have interest rates that are adjusted periodically based on a reference rate. This means that if the benchmark rate increases, the interest payments on these securities will also increase.

The income generated from these investments is collected by the fund and distributed to investors. The distribution amount can fluctuate with changes in interest rates.

Fund managers actively manage the portfolio to include a mix of floating rate securities that align with the fund’s investment objectives and risk profile. They may also adjust the portfolio in response to market conditions and interest rate forecasts.