One segment of debt mutual funds (MFs) that gets relatively less attention is the floating-rate category. This despite the fact that these funds have delivered healthy returns across timelines that are better than many other debt categories.

In general, during a rising interest rate environment, bonds that come with floating rates would be preferable as coupons get reset periodically when there is an increase in rates.

Market regulator SEBI has mandated 65 per cent of the portfolio of floating-rate MFs to be invested in floating-rate instruments. However, the floating-rate bond market is not very large and isn’t well developed. Therefore, SEBI allows these funds to convert fixed-rate coupons to floating-rate ones by using instruments such as interest-rate swaps. Disclosures on such swaps from fund portfolios are sparse, almost non-existent in factsheets. But holdings are fully disclosed though, with their credit ratings.

So, where do floating-rate funds invest? What is their portfolio profile like in terms of yields and maturities? And how many of them have a consistent long-term record? Read on to take an informed call and invest in the best schemes in the segment.

Higher yields

As indicated earlier, floating-rate bonds have periodic resets based on interest rate changes — government floating-rate bonds (FRBs) have a reset every six months, for example. In September, the coupon on GoI FRB 2033 was hiked 189 basis points to 7.42 per cent from 5.53 per cent in March. Usually, the coupons are decided based on the average of the yields in the previous three auctions and a fixed spread is added to the figure.

Most of the floating-rate funds invest a portion of their portfolio in these government FRBs.

The yields on FRBs are higher than bonds with fixed coupons currently. For example, the GoI FRB 2024, GoI FRB 2028 and GoI FRB 2033 trade at yield to maturity of 7.12 per cent to 7.97 per cent as of November 9. Bonds with similar tenor, but fixed coupons trade at yields of 6.89 per cent to 7.29 per cent. Thus, FRBs trade at 25-65 basis point higher yields.

Funds deliver

There are 12 floating-rate funds available currently. But only five of them have 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.

It is interesting to note that four of the five floating-rate funds — ICICI Prudential, HDFC, Aditya Birla SL and Nippon India — have, on an average, delivered in excess of 8 per cent on a rolling three-year basis from January 2013 to December 2022, which is nearly a 10-year period.

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.

Disclosures on floating-rate investments are patchy. Nippon India’s fact-sheet gives exposure to floating-rate notes of Reliance Industries at 5.09 per cent. HDFC fund states that exposure to derivative instruments interest rate swaps is ₹2,170 crore (total asset size of the fund is ₹15,865 crore). Other funds do not give out the explicit exposure to swaps or floating-rate bonds.

Among funds with more than five years of existence, Aditya Birla Sun Life Floating Rate Fund and Nippon India Floating Rate fund have delivered consistently and may be considered for your portfolio. One floating-rate bond can be part of your core debt portfolio as well.

ICICI Prudential Floating Rate Fund has delivered strong returns. But it has an average maturity of 7-8 years over prolonged periods, making it a long-duration play. This makes it more sensitive to interest rate movements. Exposure to AA-rated securities is also relatively higher. Investors need a much higher risk appetite if they wish to invest in this fund.

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