A floater fund majorly comprises debt securities which provide a varying rate of returns depending on market fluctuations or benchmark indices. Hence, investors can benefit from fluctuations of the business cycle, as it affects the returns generated by standard stock market instruments significantly.
Such mutual funds aim to mitigate the risk factor by primarily investing in debt tools such as corporate bonds, treasury bills, certificates of deposit, etc. as they pose as a liability to issuing entities.
Interest Rates and Floater Funds
The rate of return on investment generated by a floater mutual fund is heavily influenced by market fluctuations of interest rates. Any change (an increase of decrease) in the repo rates set by the Reserve bank of India affects the prevailing return rates of zero risk securities, as well as bonds issued by the government and public limited companies.
A rise in the repo rate (the rate at which scheduled commercial and public sector banks procure loans from the RBI) indicates an increase in the returns generated by zero risk instruments and government bonds, thereby increasing the yield of a debt floater mutual fund.
The interest rate offered by companies on their respective debt securities rise as well, so as to create substantial demand in the market. This is often required as individuals prefer to opt for government securities in the event of an increase in repo rates to gain from substantially higher returns, thereby reducing the number of individuals opting for debt tools issued by listed companies, driving down their price. In such circumstances, issuing debt securities with fluctuating return rates allows businesses to gather adequate cash flow to meet their operational expenses.
Thus, an increase in the market lending repo rate increases the returns generated by all market-linked debt securities, respectively. Investing in a floater debt fund, which primarily consists of such instruments, is subject to fluctuating yields and correspondingly fluctuating NAV, as per market changes in interest rates.
In case of a rise in the prevailing market interest rates, the returns generated by a floater fund consequently rise, making it a profitable investment venture. This often impacts the NAV units of such funds implying capital gains for investors.
Features of Floater Fund
The features of a debt floater mutual fund are –
- Investment portfolio –
A floater fund primarily invests 65% of the entire corpus in fluctuating interest-bearing debt securities of various public listed companies as well as government securities.
- Open-ended schemes –
Most floater funds are usually open-ended in nature, implying no restrictions regarding investments. Individuals willing to obtain NAV units of such mutual funds can do so at the trading value determined by the underlying assets’ value at any time, in contrast to the constraints associated with closed-ended funds which have to be traded within its NFO period.
- Risks –
A floater fund is associated with limited risks. While debt securities present in the corpus mitigate the risk substantially, fluctuating market rate has a significant effect on the returns generated through such investment schemes.
- Tenure of investment –
Floater debt funds can have either short term or long term maturity periods. Short term debt mutual funds primarily invest in government securities having tenure of less than one year (such as treasury bills, certificates of deposit, etc.). Long term funds mostly comprise corporate bonds, government bonds, and debentures in their portfolio.
Such flexibility in the tenure of investment makes floater debt funds appealing to any class of investors in the market.
Advantages of Floater Funds
Investing in what is debt floater mutual fund provides the following benefits to individuals –
- Low risk
As floater funds primarily choose among various debt instruments for their investment corpus, the risk associated with such tools is considerably low. Risk-averse individuals looking to secure the principal component can opt for such debt mutual funds.
A floater fund has less risk when compared to equity instruments, thereby posing as an ideal investment tool for individuals having a lower risk aptitude.
- High returns
While debt securities keep the principal component secure, high returns can be procured through market interest rate fluctuations. Investing in such tools during a rising market trend ensures substantial yield on investment through higher compounded interest generated on total deposits.
This allows individuals to benefit from stock market fluctuations through capital gains or periodic dividend yield pay-outs without assuming substantial risk (as present with equity investments).
Limitations of Floater Funds
Investing in a floater fund might seem like an appealing option for individuals looking for relatively stable investment options when compared to equity tools. However, such stock market instruments are associated with certain limitations which individuals should be aware of before pooling their money in such funds.
The primary limitation of investing in a floater mutual fund is that returns generated by such funds are heavily dependent on prevailing market conditions. Changes in repo rates are undertaken at the discretion of the RBI, as per the current economic condition of the country. Consequently, returns generated by floater debt securities cannot be predicted beforehand, thereby enhancing the risk associated with such investments.
A floater mutual fund is subject to taxation on any short, or long term capital gains realised in the event of sale of securities. If the fund was held for less than three years, short term capital gains tax (STCG) is levied based on the respective income tax slab of an individual. For example, if an individual’s total income earned in one financial year (including the sale of NAV units of a floater fund) ranges between Rs.2.5 lakh – Rs.5 lakh, tax levy on such capital gains shall be at the rate of 10%.
Long term capital gains, on the other hand, is levied for resale of securities after holding the same for at least three years or more. Tax at 20% of total gains is charged on such profits, after adjusting the gains for indexation.
Provision for indexation ensures individuals enjoy real-time gains from their total profits after taking into account the changes in the overall price level occurring from the time of purchase and time of sale.
Individuals looking for investment tools where their corpus remains unaffected, irrespective of stock market fluctuations can choose to invest in a floater debt fund. The only stipulated risk concerning market interest fluctuations, in this case, is the fund’s dependence on RBI monitored repo rate, which can affect the returns generated by such tools. The interest portion can deviate depending upon new policies adopted by the RBI.
Individuals whose main aim is to dilute the risk factor can choose to diversify their investment portfolio by allocating a stipulated percentage of the corpus into floater funds. This helps compensate for aggressive investment strategies undertaken by risk-prone people, as a steady flow of income can be expected during times of significant fluctuations in stock market performance through a floater fund.
Also, individuals willing to make substantial gains through interest rate fluctuations can procure NAV of such debt floater funds, provided a proper prediction regarding upcoming interest rate trends can be derived through market analysis.
When to Invest in Floater Mutual Funds?
The best time to invest in a debt floater mutual fund is during rising interest rates in a country. A contractionary monetary policy dictating a rise in the repo rates, which, in turn, raises other dependent rates is often undertaken during times of persevering inflation rates in the country. Any surplus funds parked in floater funds during such prevailing market trends will generate substantial returns on total investment.
Understanding debt floater mutual funds, its characteristics, as well as the right time for investment, can help individuals make the right decision regarding investment. Furthermore, the tenure of investment should be made in tune with predicted market conditions in the future, as well as financial goals and upcoming expenses of investors.