Floating rate funds can cushion interest rate volatility by investing in corporate bonds, treasury bills and certificates of deposit
Individuals are preferring to invest in floating rate funds due to lower chances of interest rates moving down and their ability to act as a hedge against rising rates. In October, floater funds received net inflows of Rs 5,050 crore, the second highest in debt-oriented mutual funds in the month after overnight funds which received net inflow of Rs 6,337 crore, as per data from Association of Mutual Funds in India. Investors also went for dynamic bond funds due to their ability to better navigate interest rate volatility.
While inflows in debt mutual funds continue to grow, making short to long-duration debt funds more viable, investors are also opting for a cushion of debt along with equities. In the current interest rate scenario, investors chose to mostly invest in less than one-year segments. As a result, ultra short duration funds, low duration funds and money market funds received robust flows. Other debt-oriented categories such as medium duration and medium to long duration continued to receive net inflows indicating investors are preferring fixed income funds at short to medium end of the curve.
Himanshu Srivastava, associate director, Manager Research, Morningstar India, says what makes medium duration category appeal to investors is the conservative approach towards credit. “Although there has been an improvement in their credit profile, they have emerged as the investment vehicle offering a mix of credit approach along with investments in highly rated securities. Thus, investors get to benefit from both,” he says.
Rising yields & floating rate funds
In floater funds, fund managers invest at least 65% of the fund corpus in floating-rate bonds where the duration is up to 1.5 years. The rest is invested in fixed-rate debt instruments. Experts say floating rate funds can cushion interest rate volatility as these mitigate the risk factor by investing in debt instruments such as corporate bonds, treasury bills and certificates of deposit. As the 10-year bond yield has shot up to 6.4%, investors want to take advantage of the rising yields and invest in floating funds. Also, with rising inflation, short-term rates, which are low now, could rise and lead to volatility in debt funds. In such a case, floating rate funds can act as a hedge against rising interest rates.
Brijesh Damodaran, managing partner, BellWether Associates, says if investors are expecting interest rates to go up and are uncertain on what the Reserve Bank of India’s policy on the interest rates will be and do not want to be caught off-guard, then they can park short term funds in floater funds. “This will ensure if the interest rates go up, your investment in the debt instruments aren’t adversely affected. Again this is a tactical investment and as an investor, one should not look at timing the investment as the policy makers may not act in a manner which the investor could be anticipating,” he says.
Dynamic bond funds
The normalisation of liquidity measures by RBI indicate that the interest rate cycle may have bottomed out. In such a case, dynamic bond funds which shift investments between short term instruments such as commercial paper and certificates of deposit and long term bonds such as corporate bonds and gilt securities based on interest rate movement can be a preferred option for investors. These are open-ended schemes and invest across durations. Investors, however, have to be cautious as a lot depends on the fund manager view on interest rate and a wrong call or misjudgement of the scenario could lead to underperformance in these funds. The dynamic bond fund in which they invest should hold high-quality liquid securities which will give the flexibility to the fund manager to shift funds from one duration to the other efficiently.