Interest in floating funds dwindles due to massive outflows and hesitant returns
Interest in float funds has started to wane as returns for the category have weakened in recent months. Market participants believe that with the tightening of liquidity, floating funds are experiencing negative flows.
Data from the Association of Mutual Funds in India (Amfi) shows that in February, floating funds recorded net outflows of Rs 10,323 crore, the highest in the current financial year. Over the past six months, the category has seen net outflows of Rs 8,440 crore.
Unlike normal fixed rate funds, floating funds invest a minimum of 65% in floating rate securities issued by companies or the government or convert fixed rate securities to floating via derivatives. A floating rate note offers a coupon linked to a reference rate such as repo or three-month Treasury bills. The coupon is reset periodically to reflect changes in interest rates.
Sandeep Bagla, CEO of TRUST Mutual Fund, said that over the past three months, float funds have only averaged 2-2.5% returns on an annualized basis. During the same period, cash returned around 4%. Even short-term funds generated similar returns.
“Investors are deploying funds in floating schemes, hoping to earn higher returns than fixed rate funds when interest rates rise. Disappointed investors have turned away from floating funds and its sub-optimal performance in a period where rates had increased,” Bagla added.
Typically, these funds are better suited in a situation of rising interest rates and in 2021 they were in demand as investors expected the Reserve Bank of India (RBI) to raise rates. But the central bank maintained its accommodative stance to support economic growth.
Over the past year, float funds have given average returns of 4.4%, lower than dynamic bond funds, gilt and bank funds, and PSU funds.
Joydeep Sen, corporate debt trainer, further explains: “There is something technical about it; instruments in floating rate funds will only get the higher reset on the next reset date, so there is a waiting period involved. Either way, investors were disappointed and pulled the money out of the float funds. Existing investors can hold the float funds for an adequate period of time as returns are expected to improve in the future.
Market participants say that given the current scenario, we could see rate hikes in the coming months and investors may turn to floating funds, short-term bond funds, and bank and PSU funds.
However, Sen still believes that currently, as the RBI is set to raise interest rates, target maturity funds are the best bet in the debt fund category.