Is it a good idea to invest in floater funds at this juncture?

Take a glance at what are floater funds and why to invest in them.

March 09, 2021 1:53 IST | India Infoline News Service
Debt fund flows have been quite erratic in FY21. That is not surprising considering most of the flows into debt funds are either from HNIs or institutions. Flows in and out of debt funds synchronize with cash flow surpluses and the cash flows needs like advance tax payments. However, within the overall category of debt funds, there is one category of Floater Funds that attracted genuine buying interest in FY21.

Data Source: AMFI

A quick glance at the above chart shows that AUM of Floater Funds doubled between April 2020 and January 2021 from Rs31,615cr to Rs62,638cr. Now AUM can come from fresh flows or from capital appreciation. If you look at the monthly flow chart, out of Rs31,023cr AUM accretion in floater funds, Rs27,235cr (88%) of AUM accretion is explained by fresh flows. That shows, there is a genuine buying interest building in floater funds, although the AUM base may still be relatively low. But first, what are floater funds?

What are floater funds and why invest in them?

No prizes for guessing, but floater funds or floating rate funds invest at least 65% in floating rate bonds. Such bonds may be issued by central and state governments or by corporates. These are typically variable rate instruments linked to the Mumbai Interbank Offer Rate (MIBOR), which is the benchmark for such floating rate bonds.

One problem that these funds do face is illiquidity. For example, liquid corporate floating-rate bonds are few and far between. Hence most of the floating rate funds are predominantly invested in AAA rated government bonds carrying a floating rate of interest. Secondly, due to limited supply, most floating rate funds also apply a proxy derivative strategy. They buy fixed rate bonds and use Overnight Index Swap (OIS) to hedge interest rate risks.

How floating rate funds performed in India?

The table below captures how the floating rate funds in India performed over last 1-year, 3-years and 5-years. For simplicity, we have used Direct Plans instead of Regular Plans.

Scheme Name Return 1 Year (%) Direct Return 3 Year (%) Direct Return 5 Year (%) Direct Daily AUM (Rs. Cr.)
ICICI Pru Floating Interest 8.81 8.66 8.66 13,745
Nippon India Floating Rate 8.62 8.69 8.35 13,402
Kotak Floating Rate Fund 8.41 N.A.  N.A. 4,317
HDFC Floating Rate Debt 8.07 8.17 8.06 16,941
UTI Floater Fund 7.07 N.A. N.A. 2,597
Aditya Birla Floating Rate 7.02 7.98 8.17 11,362
Franklin India Floating Rate 5.47 7.07 6.94 319
Data Source: AMFI

The average return on floating rate funds is between 7.5-8%. The returns of most of the above funds have bene relatively steady irrespective of whether you consider 1 year returns or 3 year returns or 5-year returns. Why does this stability of returns come about?

This is largely due to the fact that the yields on these floating rate funds vary with the changes in the rates in the market. Typically, the floating rate funds go up as the market yields go up and vice versa. Since the fund yields are in sync with the market yields, in most cases, there is no justification for the prices to make any adjustment. Since the choice of instruments is limited, most of the larger funds have a broadly similar portfolio. That explains the consistency in returns and yields across time periods in floating rate funds.

Are floating rate funds a good investment idea now?

Obviously, floating rate funds can give good returns only when interest rates move up or when interesting rates are expected to move up. That is when bond yields move up and that is what is happening currently. Here is why there is a case for floater funds.

a) Repo rates in India are currently at historic lows. While RBI, has held on to its accommodative stance, it is not clear how much longer they can hold rates low if growth and inflation pick up in a big way in the coming quarters.

b) One of the reasons for the fall in yields during the pandemic was surplus liquidity. With growth coming back, the government may look to unwind some of its fiscal and monetary largesse and that could tighten bond yields due to a liquidity shortfall.

c) Lastly, bond yields are going up across the world with the US bond yields up more than 1.5X in the last few months. That could coax the RBI to hike repo rates to make real rates competitive for global investors. That could boost returns on floater funds.

For retail investors, this product can be relatively complex. Also, the kind of returns of 7.5%-8% is something investors can earn even on short duration funds, so there is no additional advantage in floater funds. Also, with the government having a huge borrowing program, bond yields are unlikely to go too high. At best, floating rate funds can be a small allocation for investors within the overall debt allocation.

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