Should You Invest in Floater Funds?

Do you seek higher returns than bank fixed deposits? Are you looking at a tax-efficient investment if you fall in the higher income tax brackets? You may consider investing in floater funds that invest a minimum of 65% of their assets in floating-rate instruments. It is a suitable investment if interest rates are expected to rise in the economy. The RBI has maintained low interest rates to stimulate growth in the economy. However, many experts believe that RBI could increase interest rates in the future, which may increase the returns from floater funds. Should you invest in floater funds? 

What are floater funds?

Floater funds are debt mutual funds that invest at least 65% of their assets in floating-rate bonds. Moreover, you have the interest rates of floating-rate bonds linked to a benchmark rate that is reset at regular intervals. 

Floater funds invest in low risk fixed income instruments such as AAA-rated corporate bonds, government securities and money market instruments. However, they may invest in bonds of a longer duration and are vulnerable to interest rate fluctuations in the economy. 

Should you invest in floater funds?

You have floater funds doing well when interest rates are expected to rise in the economy. For example, floater funds have their interest rates tied to prevailing interest rates in the economy. You get a higher return from floater funds when interest rates rise over time. 

You could diversify your portfolio with floater funds to reduce the volatility in your portfolio. Moreover, it is taxed as a debt-oriented fund where long-term capital gains are taxed at 20% with the indexation benefit. You may invest in floater funds if you fall in the higher income tax brackets as they are a tax-efficient investment when compared to bank FD’s. 

You may avoid investing in floater funds if you are a novice investor in debt funds. You have these funds investing in corporate bonds and government securities of a longer duration. It makes these funds vulnerable to interest rate movements in the economy. 

What are the parameters to consider before investing in floater funds?

You must check the track record of the AMC and the fund manager before investing in floater funds. It helps if you opt for a fund house with large assets under management (AUM) as they can bear the sudden redemption pressure of large investors. 

You must check the credit quality of bonds in the portfolio of the floater fund. For example, it helps to opt for a fund with most of its assets in AAA-rated securities to minimise the credit risk.

You could take a look at the average maturity of bonds in the portfolio of the floater fund. It helps to opt for funds with a lower average maturity of bonds in their portfolio to reduce the interest rate risk. For instance, floater funds with a higher portfolio duration are more likely to be impacted by interest rate movements in the economy. 

You may invest in floater funds if you are a savvy investor who understands debt funds. Moreover, you must invest in these funds only if you have an investment horizon of over one year. In a nutshell, you must invest in floater funds to attain your financial goals only if it matches your risk appetite. 

For any clarifications/feedback on the topic, please contact the writer at cleyon.dsouza@cleartax.in