What is floater fund? (definition, characteristics, and types)

Debt instruments such as bonds or debentures offer returns to investors in the form of periodical interest. The interest rate offered by these debt instruments is either fixed or floating. Floater funds invest in instruments that deliver the latter.

What Are Floater Funds?

Investors prefer debt instruments like bonds as they offer fixed returns. They have a fixed interest rate, and once the investment matures, the pre-fixed interest is paid to the investors. But, there are other types of debt instruments that have floating interest rates. This means that the interest rate is not pre-fixed but depends on the changes their benchmark goes through.

Floater funds have more than 65% of their portfolio invested in these debt instruments. These funds aim to benefit from the fluctuating interest rate so that they can generate higher returns for the investors. The annual returns from these funds could range from 7% to 9%. In the last 5-years, floater funds have delivered average returns of 8.27%.

Characteristics And Functioning Of Floater Funds

The floating instruments that these funds invest in have their own benchmarks. The interest rate offered by the instrument changes as per the fluctuations in the interest rate of their benchmarks. It is generally seen that as the interest rates increase in the debt market, the interest rate of these floating interest instruments rises too, and the floater funds deliver higher returns.

Fixed interest instruments such as bonds lag in such scenarios as they continue offering fixed interest rates. This is why a large number of investors switch to floater funds when the interest rates are rising to earn higher returns as compared to fixed-return funds.

Key Things You Should Know About Floater Funds

Some other things one should know about floater funds are as follows:

  • Floater funds are open-ended schemes allowing investments and withdrawals throughout the year
  • If you’d like to invest in floater funds, you will have to make a lump sum investment as the Systematic Investment Plan(SIP) option is not available in floater funds
  • For taxation, floater funds are treated as any other type of debt fund

Types Of Floater Funds

Floater funds can be divided into two types:

  1. Short-term Floater Funds:These funds invest in debt securities that have shorter maturities. You will see most such funds investing in high-liquidity instruments such as government securities, deposit certificates, and T-Bills.
  2. Long-term Floater Funds: These funds are generally known to be more diversified with their portfolio composition. They invest in floating interest instruments along with considerable investments in the money market or fixed interest instruments.

Who Should Invest In Floater Funds?

It is recommended that risk-averse investors wanting to earn returns higher than mutual funds that offer fixed returns should invest in floater funds. However, it becomes important to consider that the returns from floater funds depend on the market conditions. The RBI is responsible for adjusting the repo rate as per the economic condition of the country. In a scenario where the interest rate falls, your floater fund investment could deliver returns lower than funds that offer fixed returns.