Floating Rate Funds: Definition, Interest Rates & Taxability
Floating rate funds are mutual funds that invest in bank loans and bonds that have variable rates of interest. They provide variable returns with changes in benchmark rates. These schemes also invest in fixed coupon instruments that can be converted into floating rates with Swaps.
Read on to know about floating rate funds, interest rates, features, and if you should invest in them.
What are Floating Rate Funds?
Floating rate funds are primarily open-ended debt schemes. Such schemes invest a minimum of 65% of overall assets in different floating rate instruments.
Since India has a few issuers of floater rate bonds, the floating rate bond market is not very large. So, mutual funds use derivative tools such as Interest Rate Swaps to turn the fixed coupon portfolio into a floater portfolio.
Floating Rate Fund Interest Rates
The returns from a floater mutual fund depend on the interest rate fluctuations in the market. Any change in RBI’s repo rates affects the existing return rates of bonds (issued by public limited companies and the government) and zero risk securities.
An increase in repo rates denotes a rise in the returns from government bonds and zero risk tools. Therefore, the yield from floater funds increases.
Investment in debt floater funds is subject to varying yields and correspondingly fluctuating NAV (Net Asset Value), according to the changes in market interest rates.
Features of Floating Rate Funds
The characteristics of a floater mutual fund are as follows:
- Open-Ended Funds: Most floater debt funds are open-ended in form, signifying no investment restrictions. Individuals can obtain the NAV units of such funds at the trading value, which is determined by the value of the underlying assets at any time.
- Investment Portfolio: A floating fund pre-dominantly invests at least 65% of the corpus in government securities and debt instruments with a fluctuating interest of public listed entities.
- Investment Duration: Floating rate funds have either long-term or short-term maturity periods. Long-term funds primarily invest in debentures, government bonds and corporate bonds in their portfolio. Short-term floater funds mostly invest in certificates of deposits and treasury bills (government securities) for a period that is less than one year.
- Risks: A floater rate fund involves limited risk. While the debt instruments in the corpus diminish the risks, fluctuating interest rates greatly impact the returns yielded.
Who can Invest in Floating Funds?
A floating rate fund is a suitable option for you if you are looking for a scheme where the corpus stays unaffected by stock market fluctuations. The only risk factor associated with this scheme is that it relies on RBI’s repo rate, which can potentially impact its returns.
You can also use this fund to diversify your portfolio, thereby mitigating risk factors associated with mutual fund investment. This will allow you to cover for any aggressive investment strategy that you have already taken up.
Moreover, this fund is a suitable choice for investors who wish to make considerable gains via interest rate fluctuations.
Also Read: 10 Best Mutual Funds To Invest In India with High Return [2022]
Tax Implications of Floating Rate Funds
Taxes are applicable on long-term and short-term capital gains from floater funds. Go through the rates below:
- When an investor holds the fund units for 3 years or more, he/she obtains long-term capital gains. The tax rate is 20% on such profits after applying for indexation benefits. Indexation adjustment reflects the inflation effect on the purchase price of a fund and helps to lower your tax liability.
- In case an individual holds the units for less than 36 months, he/she is liable to pay a short-term capital gain tax. The rate of tax for short-term capital gains depends on the income tax slab of the investor.
Also Read: Section 194K Of The Income Tax Act: TDS On Income From Mutual Funds
Final Word
Since floating rate funds pre-dominantly select debt securities for investment, the risk factor with such instruments is relatively low. Investors with a low-risk appetite can opt for these funds.
However, if you are looking for other similar low-risk instruments, you can opt for debts funds from Navi. You can invest with as low as Rs. 500 in any of the debts funds. The entire process is automated, and you need to pay a nominal expense ratio. To know more, make sure to visit Navi Mutual Fund.
Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
FAQs on Floating Rate Funds
1. What is an Overnight Index Swap?
Overnight Index Swap (OIS) refers to a hedging contract involving two parties, in which both parties exchange the interest receivables on a notional principal sum. These contracts can include both floating and fixed rates of interest.
2. When to invest in floating-rate funds?
The favourable time to invest in a floater debt fund is during growing interest rates in the country. A contractionary monetary initiative dictates an increase in repo rates, which, in consequence, increases other rates.
3. What are floater rate bonds?
Floating rate bonds are bonds that have fluctuating interest rates against fixed-rate bonds that have non-variable interest rates. The interest rate has a link with a benchmark rate, like Repo rate or Mumbai Inter-Bank Offer Rate (MIBOR). It also includes a quoted spread.
4. What are NAV units?
NAV (Net Asset Value) enables an investor to track a fund’s performance. Per unit NAV is measured as total assets minus total liabilities (present value) divided by the total number of remaining units. An asset management company announces the NAV of its various funds for each working day.
5. What is an exit load?
An exit load refers to a charge that an Asset Management Company (AMC) imposes on an investor for redeeming the fund units or while exiting a scheme. This is also referred to as a commission to the AMC or a penalty for exiting a fund during the lock-in period.
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Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
