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The floater debt fund category officially came into existence after SEBI's reclassification exercise. These funds predominantly invest in floating-rate bonds (at least 65 per cent), including fixed-rate bonds converted into floating-rate exposures by using derivative strategies.
Now since India has a limited market of floating-rate bonds, the majority of these funds use interest-rate swaps (exchange of interest rates between two parties) to artificially establish such exposures.
Characteristics of floating-rate bonds and how they differ from conventional bonds
Unlike traditional fixed-rate bonds, the interest rates of floating-rate bonds are periodically adjusted in line with rate changes in the economy.
That is why, the category of floater funds promise an advantage over funds which invest in fixed-rate bonds which can get adversely impacted during rising rates scenarios as there is a risk of a sudden drop in the price of the fixed-rate bond (classic inverse relation between interest rates and bond prices).
Even though we are in a rising rate environment, the category of floater debt funds has been witnessing outflows. You can read this story for more details.
Floater funds vs short-duration funds
While floater funds have a mandate on the type of underlying securities, short-duration funds have a mandate to maintain the portfolio duration between one year to three years. Thus, short-duration funds have reasonable flexibility to invest across debt and money market securities.
Given the current state of this segment in India in terms of liquidity concerns of floating-rate bonds, we believe these funds are not meant to be an investor's mainstream debt allocation. Moreover, short-duration funds are a more stable and versatile bet. Given their long-term record, they should be the core of your fixed income investments.
Suggested read: Floater funds losing sheen
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