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ShareThere are many investors who have already put in a large amount of savings in equity funds. Their exposure has crossed the limits, as set by their risk appetite, and they run the risk attached to going overboard on equities.
Investors need to look at other investment options to maintain an ideal asset allocation. Mutual funds offer various products to suit different investment styles and objectives. A floating rate fund is one such product. It provides returns with adequate amount of security.
Franklin Templeton AMC launched the first floating rate fund in India in February 2002. But with increasing volatility in the debt market, the number of such funds has gone up to 34 now. Combined, they manage Rs 31,745 crore worth of assets as on September 30, 2005, which is substantially higher than the Rs 19,984 crore a year back.
Right now, DSP Mutual Fund, Grindlays, HDFC, Prudential, Templeton, and UTI Mutual Fund have floaters which have a massive asset base of over Rs 2,000 crore, with Prudential ICICI FRF leading the pack with a corpus of Rs 2,744.08 crore.
Floating rate funds are essentially debt funds and invest in floating-rate instruments. They have the distinctive characteristic of protecting investors from interest-rate fluctuations and are meant for those investors who want to avoid the interest-rate risk. In normal debt funds, the investments are largely made in instruments having a fixed- coupon rate. Fixed-income securities witness price fluctuations as and when the interest rate in the economy changes. Prices fall when the interest rates rise and gain when interest rates soften.
This makes the security volatile and may result in negative returns in an increasing interest rate scenario, as we have witnessed over the last two years.
Though the prices of floating rate securities are also impacted by the change in interest rates, the impact is reversed as the coupon rate is accordingly adjusted.
In a floating rate bond, the interest rate is linked to a benchmark rate, such as MIBOR. The coupon rate of the bond generally has a mark-up of a few basis points over the benchmark rate and the interest rate is reset at periodic intervals, which may be as less as a day. Thus any rise in the benchmark rate is corresponded by an equivalent increase in the coupon rate, resulting in no change in the yield and consequently in the market price. Thus the floating-rate fund protects the investor from any interest-rate risk. Hence, floating rate funds are a good investment option when interest rates are expected to rise.
Floating rate bonds may not be completely risk-free. There is always a credit risk associated with them. This means that the issuer of the paper does not repay or delays the payment. Normally, the issuers of floating rate bonds are corporates with sound fundamentals and hence the credit-risk is very low. And as most floating- rate bonds are short-term in nature, the risk comes down further.
These funds are treated as any other debt fund for tax purposes and dividends as usual are tax-free in the hands of the investor, of course after taking the dividend distribution tax into consideration.
Investment in floating- rate bonds would make sense for investors looking at debt instruments. By investing in floating-rate funds, one can hedge from interest rate risks, which may look uncertain especially in the light of Fed rates being continuously pushed upwards.
The performance of the scheme is measured, taking into account the returns, expense ratio, volatility and average maturity of the portfolio. Since the returns are generally range-bound, the expense ratio becomes an important measure to choose the scheme.
The expense ratio of these schemes is generally lower than that of the income schemes, but higher than the liquid schemes. The schemes don't have any front-end or back-end load.
The author is joint MD of mutualfundsindia.com
Views are personal
