Floating rate funds a big draw as higher rates loom

Investors looking to shield their debt mutual fund portfolios in a rising interest rate environment are putting money into floating rate funds. This category of funds received the highest inflows within the debt mutual fund category — of ₹23,734 crore — in the past three months as investors believe the interest rate cycle is set to reverse.“We are at the fag-end of interest rate-cut cycle. We expect rates to be volatile due to moderation in RBI stance and liquidity. Floating rate schemes stand to benefit by providing better hedge for such market scenarios,” said Manish Banthia, senior fund manager, ICICI Prudential Mutual Fund.A floating rate fund invests in either floating rate instruments or in fixed coupon instruments that are converted to floating rate by using swaps/overnight index swap (OIS). A floating-rate bond (FRB) offers a coupon tied to a benchmark rate like the repo or the 3-month T-Bill and the coupon resets periodically to factor changes in interest rates.Prices of typical fixed rate bonds have an inverse relationship with changes in interest rates; as interest rates rise, prices of bonds fall and vice versa. Since floater bonds have a fixed reset period or floating component, in a rising interest rate scenario, it can provide support to the fixed income portfolio.Fund managers believe with economic growth picking up, RBI could be forced to normalise liquidity and could result in some rate hikes. They believe higher inflation and commodity prices minimise headroom for the RBI to keep policy rates at current levels. They also believe the global inflationary cycle is likely to have a bearing on interest rates in India.“Investors could use a floating rate fund to diversify their fixed income portfolios,” said R Sivakumar, head — fixed income, Axis MF. He points out that most investors’ debt portfolios have a long duration, and a floating rate fund could help in an environment when interest rates are rising. Floating rate schemes have lower sensitivity to interest rates, resulting in lower MTM risk. Most floating rate funds have an average duration of 0.5-1.5 years.“Investors with a time frame of 1-2 years looking to dynamically capture interest rate movements can invest in floater funds,” said Nirav Karkera, head of research, Fisdom. He recommends Aditya Birla SL Floating Rate, ICICI Prudential Floating Interest and IDFC Floating Rate and expects investors could earn a post expense return of 5-6% over the next couple of years. 86149000

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