Floater funds are debt mutual funds that invest mainly in floating-rate debt instruments. Unlike fixed-rate bonds, floating-rate instruments have interest rates that reset periodically based on a benchmark.

Under SEBI’s framework, a floater fund must invest at least 65% of its assets in floating-rate instruments. This can also include fixed-rate instruments that have been converted to floating-rate exposure using swaps or other permitted derivatives.

When interest rates go up, a floating-rate bond automatically increases its payout to match. As your interest climbs with the market, your investment doesn’t lose value. That’s the advantage of floater funds over fixed-rate schemes like corporate bond funds, gilt funds or long duration funds.

Floater funds may suit you if:

• You expect interest rates to rise: Floating-rate instruments can benefit when their interest rates reset higher. However, you should not invest based purely on your prediction of what the RBI will do next.
• You want to diversify your debt investments: If your portfolio already contains fixed-rate debt funds, a floater fund can give you further exposure to floating-rate instruments.
• You have short to medium-term goals: Floater funds are generally used for short or medium-term debt investing, ranging from 1 to 3 years. A suitable holding period depends on the fund’s portfolio and your financial goal.

A floater debt fund is still a mutual fund. Its NAV can fall. If the fund holds corporate debt and a borrower defaults, the value of your investment can decline.

When you invest in a floater fund, it uses that money to invest in debt instruments whose interest rates can change over time. These rates are usually linked to a benchmark rate, along with a fixed spread.

For example, suppose a bond has a benchmark rate of 6% and a fixed spread of 1.5%. Its interest rate would be around 7.5% (6% + 1.5%). If the benchmark rises to 6.5%, the bond’s rate may reset to around 8%.

This means floater funds can benefit when interest rates rise. However, the fund’s returns won’t automatically increase every time the RBI raises rates. The actual impact depends on the securities in the portfolio, their reset dates, benchmarks and other factors.

India has a limited supply of genuine floating rate bonds. To get more exposure, fund managers can also use interest rate swaps. These swaps can convert the interest payments on a fixed-rate investment into floating-rate payments.

So, if you invest ₹10,000 in a floater fund, the value of your investment will depend on the fund’s NAV. The interest earned by its underlying bonds is one factor, but bond prices, credit quality, expenses and other factors can also affect the NAV.

Some practical benefits of floater fund investments include:

• Lower interest rate sensitivity: Floating-rate instruments generally have less sensitivity to interest rate changes than regular debt instruments. But this doesn’t mean their prices cannot fall when rates change.
• Diversification of debt portfolio: These funds add another type of debt exposure alongside schemes such as corporate bond funds, banking PSU funds, and short duration funds.
• Can be useful when interest rates rise: When the rates on floating-rate instruments reset higher, the fund may benefit from higher interest income. This is one of the main reasons many people consider floater funds during rising rate environments.
• No mandatory lock-in period: Floater mutual funds are open-ended debt schemes. You can generally redeem your investment anytime, subject to the scheme’s terms and any applicable exit load.

You should know about certain risks related to investing in floater funds, such as:

• Credit risk: The fund may invest in corporate debt. If a company struggles to repay its debt, the value of its bonds can fall. Floating rate exposure does not remove credit risk.
• Derivative risk: Some funds use interest rate swaps or other derivatives to create floating rate exposure. These instruments introduce additional risks, including counterparty and operational risks.
• Interest rate risk is not zero: Floater funds can still be affected by interest rate changes because not all instruments reset rates immediately. The fund may also hold fixed-rate securities.
• Returns can fluctuate: A floater fund does not promise a fixed return like a fixed deposit. Its NAV and returns can change based on market conditions. For example, if interest rates fall, the floating rate can reset lower. In that case, the income generated by the fund’s portfolio can also come down.

How can you handle these risks?

Here are a couple of ways in which you can reduce your risk exposure:

• Keep your emergency money elsewhere: A floater fund is not the right place for money you may need immediately. For very short-term cash needs, you can explore options such as overnight funds or liquid funds.
• Don’t invest based only on the rate outlook: You may expect interest rates to rise but still get disappointing returns due to other factors.

Therefore, your investment decision should primarily consider your goal, time horizon and overall portfolio before investing in any fund, including floater funds.

If you are looking for the best floater mutual funds, don’t simply choose the fund with the highest return in the last year. There are other factors you must consider, such as:

• Credit quality: Don’t assume that a floater fund is safe simply because it invests in floating-rate securities. Look at the credit ratings of the bonds the fund holds. A fund with more exposure to lower-rated securities can carry more credit risk.
• Portfolio composition: See how much the fund’s portfolio comprises of actual floating-rate securities, fixed-rate securities and derivatives. The portfolio can still have some exposure to interest rate risks. Also, check the fund’s duration and understand what it means for your investment horizon.
• Check the fund’s use of derivatives: If a fund uses swaps or other derivatives extensively, understand why they are being used and what additional risks they create.
• Fund manager and track record: Look at how the fund has managed different interest rate environments and credit conditions. Past performance does not guarantee future returns, but it can help you understand the fund’s approach.
• Expense ratio: Costs reduce the return you receive. Therefore, you should always compare the expense ratios of similar funds and prefer a direct plan over a regular plan to save the distributor’s commission.

Once you pick suitable floater funds to invest in, setting up a SIP on Millions takes only a few taps on your smartphone:

• Download the Millions app from the Google Play Store or the iOS App Store.
• Verify your mobile number and complete eKYC to open your free account.
• Once you onboard, head to the mutual funds section and select the floater fund that meets your financial goals and time horizon.
• Tap on ‘SIP’ at the bottom and select how often you’d like to invest (daily, weekly, or monthly).
• Set the SIP amount, preferred debit date, and confirm details before authenticating the payment.

And that’s about it. You can invest through an SIP as well as a lump sum, depending on your comfort. But don’t start investing just because it's easy to start. First, make sure a floater fund fits your investment goal.

If not, you can explore other debt schemes such as money market funds, low duration funds or corporate bond funds to build a more diversified debt portfolio. Further, you can pair your debt investments with equity schemes like blue-chip funds, multi-cap funds or balanced schemes like multi-asset allocation funds or conservative funds.