Floater Funds

What are Floater Funds?

A floater fund is a special type of debt mutual fund that invests around 65% of its assets in floating-rate debt instruments. These funds generally invest in corporate bonds since, unlike government bonds, corporate bonds offer a floating rate of interest. Government bonds usually provide a fixed rate of interest. However, floater funds can also invest in government securities to suit their investment objectives.  

Floater funds are susceptible to the REPO (Repurchasing Option) rate set by the Reserve Bank of India (RBI). As a fact, floater funds and Repo rates share a direct relationship. If the Repo rates increase, floater funds generate higher returns and vice versa. Hence, an ideal time for investing in floater funds is when the Repo rates are in an uptrend.

Who Should Invest in Floater Funds?

Floater funds are debt funds that invest in floating-rate corporate bonds and other fixed-income instruments, including money market instruments and government securities. Floater fund returns depend on interest rate fluctuations in the economy.  

Any Indian citizen can invest in floater funds through a portfolio manager. However, investors with the following preferences generally invest in floater funds:

  • You can analyse and predict the movement of interest rates (read, Repo rates) in the economy. Floater funds usually deliver higher returns when the interest rates are in an uptrend. 
  • You are looking for a mutual fund to diversify your investment. Floater funds are generally more stable than equity funds or aggressive debt funds. Hence, these funds can efficiently reduce your portfolio’s volatility.
  • Any investor looking for less volatile fixed income instruments can invest in floater funds. These funds invest in high-quality debt instruments, making them relatively immune from volatility. 
  • You are looking for a tax-efficient mutual fund. As with all debt funds, floater fund long-term returns are taxed at 20% after factoring in indexation. The indexation feature reduces your overall tax liability. 
  • Any investor with a long-term investment horizon can invest in floater funds. These funds generally invest in long-term corporate bonds and government securities. However, choosing liquid funds or other open-ended debt funds is better if you are a short-term investor. 
  • Any first-time investor willing to understand the dynamics of debt funds can invest in floater funds to improve their understanding of the secondary market in general and interest rates in particular. 

Taxability of Floater Funds

The best floater funds are extremely tax efficient. You have to pay the same type of taxes as you will with any other debt fund. Here is a lay down on the tax implications of floater fund investments:

  • You need to pay three types of taxes if your net profits exceed INR 1 lakh from all mutual fund investments, including floater funds.   
  • Dividend Income – All dividends are taxed as per the investor’s tax slab. So, if you fall in the 10% tax bracket, you have to pay 10% of your dividend income as a tax.
  • LTCG – LTCG or Long-Term Capital Gains tax apply on all withdrawals made after three (3) years from the investment date. The applicable rate is 10% without indexation or 20% with indexation. 
  • STCG – STCG or Short-Term Capital Gains tax apply on all withdrawals made before three (3) years from the investment date. STCG is taxed as per the investor’s income tax slab.   

Risks Involved With Floater Funds

Investors generally prefer floater funds with a low-risk appetite. These funds are typically more stable than aggressive debt funds and equity funds. Here are the most common risks of investing in floater funds:

  • Dependence on Interest Rates – Floater fund returns depend entirely on the benchmark rates set by the Reserve Bank of India. Any decline in the rates may cause significant losses for floater fund investors since a rate cut adversely affects corporate bonds, government securities, and the like. Hence, it is wise to invest in floater funds after carefully analysing the macroeconomic scenario of India.
  • Credit Risk – While floater fund managers are generally cautious about selecting the debt instruments, they cannot predict a rating downgrade. If the debt instrument undergoes a rating downgrade after you invest, your fund value may decrease. And, if the issuer of the debt instrument defaults, your fund value may receive a severe blow.
  • No Control – Although you can control the amount you want to invest in floater funds, you cannot control the debt instruments the fund manager chooses to invest in. Floater fund investors depend on the good judgement of the fund manager to make profits. So, you must evaluate the fund manager’s reputation while choosing a floater fund. 

Advantages of Floater Mutual Funds

  • Minimal Risk – Floater mutual funds are much less risky than equity funds. Since these funds invest primarily in bonds, government securities, and fixed income instruments, the risks of capital loss are minimal.
  • High Returns – Floater funds are carefully crafted to minimise risks while maximising profits. While the fixed income component of these funds ensures decent returns, the floating-rate component ensures capital growth.
  • Minimum Investment – You can start floater fund investments from a lowly INR 500. Floater funds accept two types of investments – lump sum and SIP. Lump-sum refers to a ‘one-time’ investment of INR 5,000 or more. SIP or Systematic Investment Plan starts from INR 500 every month.

Diversification – Floater funds are an excellent tool for diversifying your capital investment. While you can invest a part of your capital in high-risk instruments, investments in floater funds can help you to fulfil your financial obligations.