Floating rate funds: A good buy in rising interest rate scenario

What is a floating rate fund? These are debt mutual funds which invests about 75%-100% in securities that pay a floating rate of interest (bank loans, bonds and other debt securities) while the rest is invested in fixed income securities. The primary advantage of these funds is that they are less volatile than other types of debt funds. This advantage arises due to the inherent structure of the floating rate bonds.

Floating rate funds vary from conventional fixed rate investments mainly on the basis of coupon rate i.e. the coupon is revised at regular intervals (means floating) with respect to change in the benchmark rate. Consequently, if there is a rise in the interest rate, the coupon rate usually reflects this change, thereby securing the interests of investors during rising interest rates. Usually investors turn to these funds when they look for safety for their investments.

Interest rates have been rather unpredictable and, specifically, they have been on the rise in recent times. Crude prices have risen and so has the inflation. The Reserve Bank of India (RBI) raised the repo rate by 25 basis points (bps) to 6.75% recently. With the volatility in government securities/bond prices over the last few weeks, investors are seeking a safe haven for their investments in floating rate funds.

Many investors perceive income and gilt funds as very safe investments providing steady returns. However, it is only increasing volatility in the bond market which highlights the risk of investing in debt funds. Considering the fact that not a single long term floating rate fund has slipped into the negative terrain suggests that the performance of the floating rate funds have been quite good. Investors looking for capital preservation during times of rising interest rates cannot afford to ignore floating rate investments.

However, they must note that while floating rate funds do well in a rising interest rate scenario, when the scenario turns (i.e. interest rates fall), floating rate funds underperform their fixed rate counterparts. So it’s advisable to have a debt fund portfolio with adequate allocation for various categories so that investors are well placed to benefit from various phases of the interest rate cycle.

Birla Sun Life Floating Rate Fund - STP - Growth
The fund was launched in June 2003, with an aim to generate regular income through investment in a portfolio comprising substantially of floating rate debt/money market instruments. It has more than 99% of the allocation in cash holdings.

Looking at the investment strategy, the scheme has invested in high-quality bonds which are the safest bets. This conservative approach has helped the fund generate positive returns even when the market plunged in 2008. The scheme fetched 6.02% and 7.07% returns compounded annually for 2-year and 5-year period, respectively, while its benchmark stood at 5.01% and 6.52%. Having a lower expense ratio has also been favourable for the fund.

Canara Robeco Floating Rate Fund- Growth
The fund has been in existence since March 2005 and is managed by Suman Prasad and Akhil Mittal. The scheme aims to generate income and capital appreciation by mitigating interest rate risk through investment in debt and money market securities. It has invested in CDs and CPs of high quality.

The scheme has delivered higher returns than its benchmark index across various time horizons. It fetched 9.52%, 7.81% and 7.46% returns for 1-month, 1-year and 5-years timeframe, while its benchmark was placed at 7.80%, 6.94% and 6.52% returns. Since its launch, the fund had generated 7.22% returns compounded annually.

HDFC- Floating Rate Income Fund-LTF- Growth
The fund can definitely boast of having the highest corpus in the category. Managed by Shobhit Mehrotra and Anand Laddha, the scheme aims to generate regular income through investing at least 75% of its assets in floating rate debt/money market instruments or fixed rate debt/money market instruments swapped for floating rate returns, and up to 25% in fixed rate debt/money market instruments. The scheme is suited for investors having a relatively longer holding period. The scheme has placed its bet on high-quality papers and bonds. More than 95% the scheme’s allocation is in cash holdings.

On the performance front, the fund has generated 7.68% and 9.02% simple annualised returns for 1 month and 6 months tenure. Since the launch of the fund in January 2003 the fund has delivered returns at a CAGR (compounded annual growth rate) of 6.62%. It has the lowest expense ratio in the category of 0.01%.
Ideally floating rate funds suit those investors who have a lower risk appetite as there is not much price volatility. These are good to buy in a rising interest rate scenario.