Low interest rates can drive fixed-income investors to look for other, sometimes riskier, ways to earn some additional income. This is the sole reason why floating rate mutual funds are a popular choice among investors and mutual fund companies alike.
What Are Floating Rate Mutual Funds
Floating Rate mutual funds are basically debt mutual funds which invest in fixed income securities and also floating interest rate securities like bonds, bank loans and other types of debt securities. When one invests in Floating Rate mutual funds, approximately 75% to 100% of their capital is invested in securities with a variable interest rate. The most notable advantage of a floating rate fund is that the fund is far less sensitive to interest rate changes, in comparison to instruments or funds which have a fixed coupon rate. For this reason, these funds are a popular choice among investors during times of rising interest rates which result in higher coupon or interest payments. This is also why these funds are not as popular at times when the interest rates are dropping.
Kinds of Floating Rate Funds
Floating Rate funds are commonly available as short term or long term funds. Short term floating rate funds lean more towards short-term maturities offering greater liquidity. Long term floating rate funds lean more towards long term maturities, without being too aggressive, but are placed similar to short-term funds.
Returns on Floating Rate Funds
One of the major reasons why floating rate funds are popular are because of the yields they offer. Returns provided by these funds normally range between the returns offered by high return bond funds and investment-grade bond funds.
Features of Floating Rate Funds
Floating rate funds usually form the high risk part of the portfolio due to the fact that they invest in debts of borrowers with low credit quality. As a result, majority of the income earned by way of floating rate funds is only credit risk compensation. Given that the default recovery rates for floating rate loans are higher than those of high-yield bonds, floating rate funds are at a lower risk of credit losses. At a time when the economy is recovering as a result of which credit spreads are tightening, that is a good time to invest in floating rate funds.
Floating rate loans come with a typical maturity period of about 7 years, wherein the underlying interest rate will be adjusted on the basis of any changes in the reference rate, every 30 to 90 days. Due to this, market value of floating rate loans will not be as sensitive to changes in rates of short term borrowing, as compared to other fixed rate investments. As a result, floating rate funds become far more appealing to investors at times when the market is improving and rates of short term borrowing are also improving.
Diversification of Portfolio
Floating rate funds have a unique structure because of which they conventionally have fewer links with major asset classes like municipal bonds, high-grade corporate bonds, government bonds and stocks. For his reason, these funds enable investors to diversify their portfolio.
GST rate of 18% applicable for all financial services effective July 1, 2017.