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Baroda BNP Paribas has rolled out its floater fund NFO, which will remain open till April 24.
The market regulator SEBI has mandated 65 per cent of this type of funds portfolio invested in floating rate instruments. However, the floating rate bond market is not very large and isn’t well developed in India. Therefore, SEBI allows these funds to convert fixed rate coupons to floating rate by using instruments such as interest rate swaps. Disclosures on such swaps aren’t made explicitly in fund factsheets. But all the bond holdings are fully disclosed, along with their credit ratings.
As floater bonds can be issued across maturities, the duration risk can be managed quite well. Barring sharp spurts in interest rates, when they could suffer mark-to-market losses, they tend to be hedged well and suffer lower price erosion than fixed rate bonds. Most of the floating rate funds invest a portion of their portfolio in government floating rate bonds (FRBs).
Big Story: How to ride rising rates
The government’s FRBs have a reset every six months. In September 2022, the coupon on GOI FRB 2033 was increased by 189 basis points to 7.42 per cent from 5.53 per cent in March 2022. This has been increased further by 109 basis points in March 2023 to 8.51%.
Usually, the coupons are decided based on the average of the yields in the previous three auctions of the 6-month treasury bill (T-Bill) and a fixed spread is added to the figure.
Similarly, the GOI FRB 2028 has seen coupons increased by 295 points from April 2022 to levels to 7.88 per cent now. The GOI FRB 2034 is likely to see a 260 basis points increase in coupons over the same period to 7.98 per cent.
As of March 31, the GOI FRB 2028, GOI FRB 2033 and GOI FRB 2034 traded at yield to maturity of 8.18 per cent to 8.5 per cent, much higher than fixed coupon bonds.
Fund strategy
The BNP Paribas Floater Fund will invest in a combination of bonds. It will invest in floating rate bonds of several issuers, ensuring that coupons are increased when the rates rise. It will also invest in fixed rate bonds so as to manage portfolio duration and liquidity – thereby making sure of risk reduction when the rates fall.
Additionally, the fund will use interest rate swaps to convert fixed interest rate bonds to floaters as a tactical call as well as to hedge the portfolio against any interest rate scenario.
But, how have the floater funds done? There are 13 floating rate funds, with only five having a track record of more than five years. These five funds have been around for 13-21 years, even before the separate SEBI mandated debt category came into being in 2017-18.
Four of the five floating rate funds – ICICI Prudential, HDFC, Aditya Birla SL and Nippon India – have, on an average, delivered 7.8-8.2 per cent returns on a rolling three-year basis from April 2013 to April 2023.
Floater funds have average maturity profile ranging from one year to as high as eight years. Most are in the 3-4-year range.
Apart from investing in sovereign FRBs as mentioned earlier, these funds deploy sums in corporate floating bonds as well.
Privately placed bonds, non-convertible debentures, additional tier 1 or tier 2 bonds, commercial papers, perpetual bonds and certificates of deposits are common instruments that these funds invest in.
Most of the portfolio, usually more than 90 per cent, is made up of bonds with the highest AAA rating. For shorter term papers, exposure is to instruments with the highest A+ ratings. Exposure to AA securities is usually less than 5 per cent.
Should you invest?
Even though there are a limited number of floater funds and fewer still with long track records, the existing top 3-4 schemes have done well over the past decade. Even in adverse market conditions, the drawdowns have been low (1-2%). Therefore, the category must find a small place in an investor’s debt portfolio.
Those wishing to go proven names can consider the top established schemes in the category and wait for Baroda BNP Paribas Floater fund to develop a track record before taking exposure.
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