Floater Funds: How Floating Rate Debt Funds Work in India
A floater fund is a SEBI defined debt category that must invest at least 65 percent of its assets in floating rate instruments. A floating rate instrument is a bond whose coupon does not stay fixed. It resets at set intervals against a benchmark rate, so the interest you earn moves with the market instead of being locked at issue.
The appeal is straightforward. When interest rates rise, a fixed coupon bond loses price because its coupon is now below market. A floating rate bond mostly avoids that hit, because its coupon simply resets higher at the next reset date.
The catch is that Indian floater funds rarely get there by owning only floating rate bonds. Most build the exposure synthetically, and that construction carries risks the category name does not hint at.
How a floating coupon actually resets
Government floating rate bonds in India typically reset against a benchmark derived from recent 182 day treasury bill cut off yields, plus a fixed spread. Corporate and bank floating paper may reset against MIBOR, the repo rate, or a T-bill linked benchmark. The reset can be quarterly, half yearly or annual.
Because the coupon catches up with the market at each reset, the price sensitivity of the instrument is tied to the time until the next reset, not to the final maturity date. A bond maturing in seven years with a quarterly reset behaves, on rate risk, more like three month paper.
The swap based construction most funds use
India does not have a deep supply of floating rate corporate bonds. So fund managers commonly buy ordinary fixed rate bonds and then enter an overnight indexed swap, receiving a floating rate and paying a fixed rate. The combined position behaves like a floating rate holding, and it counts towards the 65 percent requirement.
That is legitimate and disclosed, but it means three things you should know:
- The underlying bonds may have long maturities, so credit and liquidity risk are those of the actual paper, not of short term instruments.
- The swap benchmark and the bond’s own funding cost can move apart. That gap is basis risk, and it can hurt even when your rate view is right.
- The reported average maturity of the portfolio can look long while the modified duration looks short. Read both numbers in the monthly factsheet, not just one.
When floater funds work and when they do not
These funds do well when short term rates are climbing faster than the market had already priced in. Coupons reset upward, accrual improves, and prices hold better than in a fixed coupon fund of similar maturity.
They struggle in the opposite phase. Once the RBI starts cutting the repo rate, the benchmark falls, coupons reset lower and the yield you receive drops. A plain fixed rate fund, or a fund carrying real duration, would have gained price in that same cycle.
| Category | SEBI requirement | Main risk | Best phase |
|---|---|---|---|
| Floater fund | Minimum 65 percent in floating rate instruments | Basis risk, credit risk of the underlying bonds | Rising or unexpectedly higher short rates |
| Low duration fund | Macaulay duration of 6 to 12 months | Modest rate risk plus credit risk | Stable to mildly rising rates |
| Short duration fund | Macaulay duration of 1 to 3 years | Meaningful rate risk | Peaking or falling rates |
What to check before buying one
- Portfolio composition: how much is genuine floating rate paper and how much is fixed rate bonds converted through swaps.
- Modified duration: this tells you the rate sensitivity. A rough rule is that NAV moves by about the modified duration multiplied by the change in yields. A fund with modified duration of 0.8 loses roughly 0.4 percent if yields rise 50 basis points.
- Credit profile: check the rating breakup and the potential risk class matrix that SEBI requires every debt scheme to disclose, which places the scheme in a cell for both credit risk and interest rate risk.
- Expense ratio: in a category earning short term accrual, half a percent of extra cost is a large share of the return.
Tax treatment
Floater funds are debt schemes for tax, so equity rules do not apply. The treatment of schemes investing predominantly in debt and money market instruments changed from April 2023 and was refined afterwards. Check the current provisions of the Income Tax Act before planning a redemption.
Frequently Asked Questions
Is a floater fund the same as a liquid fund?
No. A liquid fund holds instruments maturing within 91 days and is meant for very short parking. A floater fund can hold much longer dated paper whose coupon resets, so it carries more credit and basis risk in exchange for higher accrual.
Do floater fund NAVs ever fall?
Yes. Credit spreads can widen, swap spreads can move against the fund, and the small residual duration still reacts to yields. The falls are usually shallower than in a duration fund, not absent.
Why does my floater fund show a long average maturity?
Because the underlying bonds may be long dated fixed rate paper hedged with swaps. The modified duration number is the one that reflects rate sensitivity, so read it alongside average maturity rather than judging by maturity alone.
Should I switch to a floater fund when the RBI raises rates?
By the time a hike is announced, bond prices usually reflect it. Switching after the news often means paying the exit cost and tax without capturing the benefit. Choose the category for your horizon and risk tolerance rather than for a rate forecast.
Key Takeaways
- SEBI requires floater funds to hold at least 65 percent in floating rate instruments.
- Coupons reset against a benchmark, so price sensitivity is tied to the reset date, not final maturity.
- Most Indian floater funds use fixed rate bonds plus overnight indexed swaps, which adds basis risk.
- They help when short rates rise faster than expected and lag when the rate cycle turns down.
- Debt taxation applies and the rules changed recently, so confirm the current position before redeeming.
