Understanding Floating Rate Funds
Floating rate funds hold bonds whose interest resets with the market — useful when rates are rising. Here’s how they work.
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A floating rate fund is a debt fund that invests mainly in bonds whose interest rate resets periodically with a market benchmark — rather than paying a fixed coupon. This makes them behave differently from regular debt funds when rates move.
Fixed vs floating coupons
A normal bond pays a fixed coupon, so when market rates rise, its price falls (interest-rate risk). A floating-rate bond’s coupon adjusts upward as rates rise, so its price is far less sensitive to rate changes — it has low effective duration.
Why investors use them
- Rising-rate protection — when the RBI is hiking the repo rate, floating-rate funds’ income rises and their prices hold up better than fixed-rate long-duration funds.
- Lower interest-rate risk than longer-duration debt funds.
The caveats
- Not immune to risk — they still carry credit risk, and some use derivatives/swaps to create floating exposure, which adds complexity.
- Underperform when rates fall — the flip side: in a falling-rate environment, fixed-rate (longer-duration) funds gain more, while floating-rate income drops.
- The call depends on the rate cycle — floating-rate funds shine when rates are rising or expected to rise.
Who they suit
Investors who want relatively low-volatility debt exposure and are worried about rising rates. As always, match the fund to your horizon and read its portfolio. Rate timing is hard — these aren’t a free lunch. Education only, not a recommendation.
