The Supreme Court on Thursday permitted Franklin Templeton trustees to call a meeting of its unit holders to seek their consent for the closure of 6 debt funds, even as requests of redemption from investors remain suspended.
Steps to call the meeting will have to be taken within a period of one week.
“The Hon’ble Supreme Court on December 3, 2020 issued an interim order allowing the Trustee of Franklin Templeton to seek consent of the unitholders for the winding up of the six schemes u/r 18(15)(c) of SEBI (Mutual Fund) Regulation 1996. Redemptions will continue to be suspended till further notification,” said a Franklin Templeton spokesperson.
Interestingly, according to Bar & Bench, which tweeted the SC proceedings live, the apex court asked SEBI that if they knew people will withdraw money like anything during COVID, why didn’t SEBI do something like RBI? In response, Advocate Pratap Venugopal for SEBI said that the regulator doesn’t have any powers in the winding up process.
Franklin Templeton MF said it believes that the Supreme Court order will be helpful in ensuring orderly monetization and distribution of scheme assets.
The fund-house is expected to issue the notice for seeking consent of unitholders shortly. It hoped to commence distribution of investment proceeds at the earliest. The cash available (for distribution) as of November 27, 2020 stands at Rs 7,226 crore for the four cash positive schemes, subject to fund running expenses.
Franklin Templeton MF had approached the apex court against the Karnataka High Court’s decision according to which prior consent of unit holders was required to close the six debt fund schemes during the pandemic. The closure was challenged due to the fact that no consent was taken from investors. But according to Franklin Templeton, it was under the impression that no prior consent or approval was required from investors.
The six schemes are Franklin India Low Duration Fund, Franklin India Ultra Short Bond Fund, Franklin India Short Term Income Plan, Franklin India Credit Risk Fund, Franklin India Dynamic Accrual Fund and Franklin India Income Opportunities Fund.
There are many kinds of buyers and sellers in the stock market. They are often classified as speculators, traders or investors based on how they view the stock investments and how long they are holding the stocks.
While speculators are those who look at the daily or hourly movements of stocks in the stock markets, traders are those who buy or sell stocks on a daily or weekly basis. Speculators and traders churn stocks very frequently. This could in a few months, weeks or days, sometimes even a few minutes. Investors, on the other hand, don’t look at the technical indicators for the stocks. They look at the fundamentals, financials and management philosophy of the company or the mutual fund house before investing in the stocks or mutual funds. They hold the investments for years or even decades to make profits over the long term. While speculators and traders have more possibility for losses, there will be very limited losses for investors if they choose the right stocks or mutual funds. Here’s why you need to be an investor in equities who invests for the long term.
No need to time the market
Trading is a different game. To be successful at trading, the trader needs to have a certain amount of money to start with. This is often much higher than that needed for an investor. Traders need to dedicate time on a daily basis if they want to make profits. Traders also need to develop a level of experience for identifying when to buy and sell stocks. Trading profits are made by buying at a lower price and selling at a higher price. This needs to be done within a relatively short period of time. This could result in profits or losses. So, the traders need to have high risk tolerance. So, it is clear that traders need to time their investments and not everyone can be a trader.
However, an investor needn’t keep reviewing the investments on a daily basis. The investor needs to do some basic research on the investment or can take the help of an investment advisor to choose the right stocks or mutual funds for the long term. Investors needn’t bother about short term downturns in stock prices. On a day-to-day basis, stock prices experience fluctuations. However, in the long run, stock prices reflect the value of the business. Therefore, a stock’s price will move upwards in the long term if the fundamentals of the company are good.
Lower possibility of losses
Since stock prices are not predictable, traders can make profits or losses depending on the movements of the markets. If they don’t monitor the prices or don’t predict them well, they could lose some part of the capital they invested. This is not the case for investors.
Equity markets tend to do well over the long term. Take the Nifty 50 index. 15 years back, the Nifty was at 1900 levels. Today, Nifty has touched 12,900. So, markets keep moving up over the long term.
Apart from the capital gains that investors get when markets move upwards, investors can even earn income such as dividends while they are holding the stocks or equity funds. So, the prospects of investors making losses on investments over the long term is low.
Why short-term equity investing doesn’t work?
Let us consider the monthly returns from Nifty 50 this year to understand this.
Month
January
February
March
April
May
Nifty Returns
-1.7%
-6.3%
14.7%
-2.8%
7.5%
If you wanted to invest on a monthly basis, you would have had to time the market. While the markets have given negative returns most of the months, there are months where there are positive returns. Let’s take another year, say 2014.
Month
January
February
March
April
May
Nifty Returns
-3.4%
3%
6.81%
-0.1%
7.9%
There are months were the Nifty has provided negative returns, there is no pattern in returns on a monthly basis. What about yearly returns? Can you invest in the markets for a year and make profits? The data below will help.
Year
Nifty Return
2012
27.7%
2013
6.7%
2014
31%
2015
-4%
2016
3%
2017
29%
2018
3.1%
2019
12%
Even if you wanted to invest for a year which is a short term, you would have had to time the markets. So, investing for the short term doesn’t work for equities.
However, long term investing does work. If you look at the five-year return for Nifty, it is a good 63%. What about ten-year returns? It is 119%.
Therefore, equity investors need to give time for their investments to do well and for returns to compound over a long period. Remaining invested for a minimum period of 5-7 years is advisable for equity. This way you can gradually build wealth over an extended period of time. You can get the benefits of perks such as dividends and stock splits along the way. You will “ride out” the downtrends in the stock market in the long run.
Franklin Templeton Mutual Fund – whose six debt funds are under winding up procedure – has collected a whopping Rs 1,895 crore from maturities, pre-payments, and coupon payments during the period November 14 to 27. This is more than double of the Rs 941 crore collected in the previous fortnight, which was itself double of the amount collected by the 6 funds in October 16 to October 29 fortnight.
Cash registers ringing
With the Rs 1,895 crore collected in the latest period, the total cash flows received by the 6 debt schemes till date now stands at Rs 11,576 crore till 27 November 2020. Out of which, Rs 2,836 crore was received in the month of November.
More importantly, out of the Rs 1,895 crore coming in, as much as 87% or Rs 1,664 crore was from pre-payments. A large proportion of pre-payments could indicate the strength of the borrowers who, even in a Covid-19 affected economy, are pre-paying debt. This should assuage some worries of investors about the portfolio health of the six embattled debt funds.
The cash available (for distribution) as of November 27, 2020 stands at Rs 7,226 crore for the four cash positive schemes, subject to fund running expenses.
Scheme level details
Individually, Franklin India Low Duration Fund, Franklin India Ultra Short Bond Fund, Franklin India Dynamic Accrual Fund and Franklin India Credit Risk Fund have 48%, 46%, 33% and 14% of their respective AUM in cash right now. These are the four cash positive schemes.
Borrowing levels in Franklin India Short Term Income Plan at Rs 943 crore or 17% of AUM and Franklin India Income Opportunities Fund at Rs 497 crore or 29% of AUM continue to trickle down, but they are not cash positive yet. In fact, the absolute borrowing amount for both the schemes has remained constant since October 29. Each scheme can return monies to investors only after paying all the obligations/ liabilities towards borrowings/ expenses/provisions.
According to Franklin Templeton MF, post the judgement of the Hon’ble High Court of Karnataka, the AMC has considered all possible options over the last few weeks to start returning money to unitholders “in the shortest possible time in an orderly manner”. This included the option of seeking unitholder consent according to the judgment of the Hon’ble High Court. However, after detailed deliberations, the fund-house determined that it will be necessary to seek judicial intervention from the Hon’ble Supreme Court to ensure an appropriate implementation of the law in the best interest of unitholders.
All mutual funds invest in securities from the stock and debt market that will help them provide returns. Different equity mutual funds invest in several stocks from various sectors. The stocks could be across market capitalisations. For instance, large cap funds invest in some of India’s biggest companies in terms of market capitalisation. Investments can be based on styles such as value and growth. So, mutual funds differ based on investing approaches such as market capitalisation, style and sector.
Coming to thematic funds, these are funds that invest based on a theme. For instance, if a fund follows an agricultural theme, it will invest in companies that are related to agriculture such as farming, tractors, fertilisers, etc. This is why thematic mutual funds are different from funds that follow conventional investing.
Thematic funds invest across different industries and market capitalisations as long as they are related to the theme. As per guidelines given by the Securities Exchange Board of India (SEBI), the minimum investment in equity securities of a particular theme can be 80% of the total assets. So, a thematic fund is more focused than a diversified equity fund.
How are thematic funds different from sectoral funds?
A sectoral fund will only focus on just one particular industry or sector. These funds invest only in businesses that operate in that specific sector or industry. For instance, a sectoral fund may invest in sectors such as finance, Information Technology, Pharma, Banking, etc.
Thematic funds focus on a theme and can encompass different sectors. Themes could be rural consumption, defence, etc. So, thematic funds could invest in more sectors. For instance, infrastructure may be the theme of a mutual fund and it will invest in all sectors that can get gains from the theme. When infrastructure spending goes up, then it will help all the related sectors to do well as their revenues will increase. This will include sectors such as cement, steel, and power. So, a thematic fund with infrastructure as the theme can invest in all these stocks that look to benefit from this theme.
When you invest in a sectoral fund, there is no diversification as the focus is on one sector. If the sector doesn’t do well, the fund won’t give you good returns. However, in thematic funds, there will be some amount of diversification as the investments will be across sectors. Even if companies from one sector don’t perform well, other sectors will protect the fall in the fund’s returns.
Should you invest in thematic funds?
If you have a high-risk appetite, want more returns and are looking to diversify your mutual fund portfolio, you could invest in thematic funds. You need to be clear about the theme and understand how it will help stocks do well in the long run. There are many thematic funds that have given decent returns in the past year. For instance, Aditya Birla Sun Life Digital India Fund has given over 43% in one year while the annualised returns of the fund for the past three years are 24%. If you look at SBI COMMA Fund, the one-year returns are 17.3% while the five-year annualised return is 14.9%.
What to look for in thematic funds?
You need to see if the investment theme offers enough quality stocks for the fund to invest in. Another point is that the theme cannot be ambiguous or too vast such that the fund can invest in any stock. Take the HDFC Housing Opportunities Fund. This fund invests in all sector related to housing. This includes banks, housing finance companies, real estate, cement companies etc. The theme of the fund is not very precise or specific. While the fund has done well in the short term, the long-term returns are negative.
You need to make sure that the theme is sustainable. For instance, defence could seem a great theme. However, defence stocks haven’t done really well. So, choose themes that are viable and will remain meaningful in the long run.
Franklin Templeton Mutual Fund – whose six debt funds are under winding up – have collected Rs 941 crore from maturities, pre-payments, and coupon payments during the period October 30 to November 13. This is more than double of the Rs 438 crore collected in the previous fortnight October 16 to October 29. Collection up With the Rs 941 crore collected, the total cash flows received by the 6 debt schemes till date now stands at Rs 9,682 crore. Out of this total amount, the actual cash available stands at Rs 5,952 crore as of November 13, 2020 for the 4 cash positive schemes, subject to fund running expenses. So, investors can get some money back as and when the courts allow payouts from the schemes that are currently in the winding up process. Only those schemes which are cash positive can pay out in such a situation. At the moment, there is no direction from courts to Franklin Templeton in terms of returning the free cash lying in schemes. Prepayments Prepayments are happening at a fast clip. Out of the received Rs 941 crore during the period October 30 to November 13, 2020, as much as Rs 814 crore was received as pre-payments. Among the cash positive funds, Franklin India Ultra Short Bond Fund (FIUBF), Franklin India Low Duration Fund (FILDF), Franklin India Dynamic Accrual Fund (FIDA) and Franklin India Credit Risk Fund (FICRF) have 43%, 27%, 26% and 8% of their respective AUM in cash. Borrowing levels in Franklin India Short Term Income Plan (FISTIP) at 18% of AUM and Franklin India Income Opportunities Fund (FIIOF) at 30% of AUM continue to come down, but they are not cash positive yet. Each scheme can return monies to investors only after paying all the obligations/ liabilities towards borrowings/ expenses/provisions.
There is a plethora of mutual funds in the marketplace today. This includes several exotic products that were launched this year. There seems to be some kind of interest shown by mutual investors as this has not been a great year for many investors. Here are the details regarding the mutual funds that have been launched and whether you should have a look at them.
Why are mutual funds launching these products?
The main reason why Asset Management Companies (AMC) are coming out with these funds is because there is no cap fixed by the Securities Exchange Board of India (SEBI) for the New Fund Offerings (NFO) of niche mutual funds. Another reason is because the AMC needs funds. Launching more funds will help them get more assets to manage.
Are these products in demand?
The answer is no. The mutual fund distributors can earn a fair bit of money by pushing these products to the investors. So, their push makes it seem like the niche mutual funds are popular.
Which are the niche funds that have been launched?
The products include environment social governance (ESG) and special situations funds, multi-asset funds and exchange-traded funds (ETFs) based on smart-beta strategy.
What are ESG funds?
These are socially responsible funds, that is, the funds identify companies that do business the right way and invest in them. They look at those companies that are well positioned to exploit all the opportunities. So, stocks of companies that manufacture products such as tobacco or alcohol are ruled out. These are thematic funds.
There are no major advantages for this fund over other equity diversified funds. This is just for those investors who sentimentally might feel that they shouldn’t invest in stocks that are against their value system.
What are multi-asset funds?
Multi-asset funds are hybrid mutual funds that invest a minimum of 10% of their assets in at least three asset classes. Most of the times, these funds invest in equity, debt and one other asset class such as gold or real estate. So, multi asset funds invest across different asset classes. There are AMCs that have started adding asset classes such as international equity to multi-asset funds. The idea is to offer diversification for the investor so that risks are reduced.
The main advantage of this fund is that it invests in different asset classes. Since all asset classes don’t underperform at the same time, the fund may not grossly underperform.
What are smart beta strategy ETFs?
Smart beta ETFs aim to provide enhanced returns with reduced risk using diversification. Here diversification is not in terms of traditional evaluators such as sector weightages. Smart beta ETFs make use of specific characteristics, such as dividend growth, stock momentum, low volatility or high quality to diversify the portfolio. It uses a rules-based system for choosing stocks to be included in the fund portfolio.
The advantage here is that the stock selection is niche and is unconventional. Since the filters are of higher standards, the fund might do better than traditional peers.
Should you invest in niche mutual funds?
The main thing to be considered here is that niche funds such as ESG funds are risky because they have no track record and you will have to wait it out to see if they perform well. If you are comfortable with this, you can consider investments in these funds. This means they need to be strictly used for only the long-term goals.
Whether you should invest in them will depend on your risk appetite, financial goals and diversification requirements. If you are knowledgeable about mutual funds or if your financial advisor recommends them, you could consider investing in these funds for the sake of diversification. However, you should see if it suits your risk appetite and financial goals. Understand that an over diversified portfolio will lower your returns in the long run. So, add the funds to your portfolio after careful consideration or after discussing it with your financial advisor.
For retail investors who don’t have much knowledge on how these funds, it is best to stick to equity funds that have a good track record and have been known to give good returns.
Every investor who is starting to invest in mutual funds is told that large cap funds are the ones to start with. However, the truth is that these funds haven’t provided investors with good returns this year because of the pandemic and other economic reasons. Mid cap and small cap funds seem to have done much better than the large cap ones. This may be one of the reasons why beginners and low risk mutual fund investors want to choose passive investing such as investing in an index fund.
What is an index fund?
An index fund is a mutual fund that invests in the same set of stocks as in a chosen index and in the same weightage. This means the mutual fund will closely follow the index and the returns will be as per the index movements.
However, there could be a small difference in the returns of the mutual fund and the index. This is called the tracking error. Tracking error shows a mutual fund’s consistency versus a benchmark index over a given period of time. Even mutual funds that seem rightly indexed against a benchmark index may behave differently than the benchmark. That is why investors need to always look for an index fund with the lowest tracking error. If the index fund is providing low average returns and has a large tracking error, you will need to understand that the index fund is not the right one.
What are the advantages of index funds?
The main advantage of index funds is that they are relatively low-risk options when compared to other equity funds. This is because there is no fund manager involved who takes investment decisions. Your returns will be wholly based on the market.
Another advantage of index funds is that they are inherently diversified. This is because they represent several different sectors within an index. Even in case of diversified, actively managed equity funds, there might be sector concentration depending on the fund manager’s decisions. However, for index funds the weightage for the stocks will be across different industries. So, your portfolio will remain safeguarded from sector concentration.
The third advantage is that index funds could provide good returns over a longer time horizon. If you look at the Nifty and the Sensex in the past decade, they have provided good returns. The Sensex has provided investors with 63.07% in five years and 103.5% in ten years. Nifty has given 57.43% in the past five years and 97.75% in ten years. So, you could get good returns by investing in index funds for the long run.
Another primary advantage of index funds is the low expenses incurred by these funds. Index funds come with a low expense ratio. Actively-managed funds come with higher expenses because the fund manager manages the portfolio and trades in securities. Transactions costs for an actively managed fund are higher. A low-cost index fund allows you to invest in the stock market without spending much money. The low expense ratio also means that the returns you get from the index fund will be higher.
Index fund also come with the advantage of easy tracking. You don’t need to look at parameters such as fund manager’s expertise, alpha wtc, for investing in an index fund. As long as the tracking error is low, you can invest in an index fund. Tracking the stock market is enough to track the fund.
What are the disadvantages of index funds?
The main disadvantage of index funds is the lack of flexibility. Fund managers of index funds cannot invest in different stocks when there is a market downturn. So, the losses cannot be limited by investing in stocks other than the ones in the index. However, actively managed funds can choose to invest in stocks with different market capitalisations, especially when the markets are volatile. This helps improve returns and limit losses.
Another major disadvantages is that index funds cannot beat market returns. They will either provide returns equal to that of the market or slightly lower than that of the market. If you want returns that are much higher than that of the market, you will need to invest in actively managed mutual funds.
Should you invest in index funds?
Index funds aren’t recommended by financial advisors because in India, more than 75% of the fund managers are able to provide returns that are much higher than that of the market. This is unlike the developed markets where only a handful of fund managers are able to do that. So, the returns from actively managed funds such as midcap and small cap funds are much higher than that of index funds.
The recent decent performance of index funds versus large cap funds is because of the market rally. However, passive funds may not beat active ones in the long run. Several actively-managed funds continue to beat their benchmark by a wide margin. Investors should look at actively managed funds if they need higher returns. Don’t know which funds to choose? Ask your consultant at wealthzi.com.
There are many options for you to save taxes under Section 80C of the Income Tax Act. Two of the most popular ones are the Equity Linked Savings Scheme (ELSS) mutual funds and the Public Provident Fund (PPF). Both the investments offer tax benefits of up to Rs. 1.5 lakhs under Sec. 80C. You need to understand both and look at them in relation to your life goals to find out which one will suit your portfolio.
What is ELSS fund?
These are a kind of equity mutual fund that are specifically launched to help you claim tax benefits while generating long term wealth for you. They come with the lowest lock-in among tax saving products. ELSS lock in is just three years. You can start investing for as low as Rs. 500 per month.
What is PPF?
This scheme was primarily launched by the government for helping people save taxes and for accumulating money for the investor’s retirement. The government announces the interest rate for PPF every quarter. For Financial Year 2020-21, October-December quarter, the interest rate is 7.1%. PPF has the longest lock in of 15 years. However, you can get a loan against your PPF investment from the third year.
What are the differences between ELSS and PPF?
The two investments are different on several parameters.
Investment risk
ELSS is risky because it invests in the stock market. Only those investors having a medium to high risk profile should consider investing in ELSS funds. PFF is a government backed scheme and there is hardly any risk of capital loss.
Returns
ELSS can provide much higher returns than PFF in the long run. Consider this: best ELSS funds such as SBI Tax Advantage Fund and Quant Tax Plan have provided annualised returns of over 15% in the past five years. The ten-year annualised return of Axis Long Term Equity Fund is close to 14%. When you compare the average return of PPF which is 7%, ELSS seem to be score here. However, the returns from ELSS are not fixed or guaranteed.
Tax on gains
The income you earn from PPF is totally tax free. However, for ELSS, you will need to pay capital gains of 10% if your long-term capital gains exceed Rs. 1 lakh.
Holding period
You will need to stay invested in PPF for 15 years. ELSS has a shorter lock in of three years. However, you can continue to hold the investment until you redeem.
Maximum investment tenure
You can hold your PFF for 15 years and this can be extended only by 5 more years. You will need to withdraw the money at end of maturity. However, you can hold on to your ELSS investment for any period of time you need.
Market volatility
ELSS is a stock market linked investment and is hence affected by the stock market movements. Even though PFF interest is fixed, the interest rates have been linked too government security rates and are changed every quarter.
Investment amount
You can invest in both PPF and ELSS on a monthly basis or you can make a one-time investment in them. The minimum investment for PFF is Rs. 500 a year and the maximum you can invest is Rs. 1.5 lakhs for a financial year. For ELSS, the minimum investment is Rs. 500 for the Systematic Investment Plan (SIP) and there is no limit to the amount of investment you can make in ELSS.
Withdrawal options
For PPF, you can withdraw money from the sixth year while for ELSS, you can redeem after three years.
ELSS or PFF: Which to consider?
As a taxpayer and an investor, you should consider your investment goals, your tax saving requirements and your risk profile before choosing one of them. You should make a note of the premature withdrawal option if you are not investing for the very long term. If you may need any funds within five years, PPF will not be a great option. If you want to save taxes while generating wealth, you can consider investing in ELSS funds.
Indian equity benchmark Nifty 50 has now gone back to Pre-COVID levels, and is perched at over 12,000 levels comfortably. With the US Presidential election result out over the weekend, all eyes are now on how domestic markets will behave given that the outcome of a crucial global event is now known. What should investors do now to ride the wave? We discuss smart ways to deal with the situation.
* Bullish stance
1. ETFs, index funds
For investors who want to go long on the index levels, a low-cost way is to purchase index funds and exchange-traded funds (ETFs) that track Nifty, Nifty 100, Nifty Next 50 etc. Passive investment products copy the target index, without any fuss related to fund manager and stock selection. The largest ETF is SBI ETF Nifty 50. The largest Nifty index fund is UTI Nifty Index Fund. Axis Nifty 100 Index Fund is the biggest one tracking the Nifty 100 benchmark. ICICI Pru Nifty Next 50 Index Fund is the biggest index scheme tracking the Nifty Next 50 benchmark.
2. Actively managed MFs
Equity mutual funds, which are managed by professional fund managers, are called actively managed schemes. Do note that actively managed funds cost more for the investor. Here, the stock selection and portfolio management is done by the fund managers. In the largecap space, the best 1-year largecap performers are Canara Robeco Bluechip, JM Large Cap and IDFC Large Cap. In the large & midcap product space, the best performers in the last 12-month period are Canara Robeco Emerging Equities, Axis Growth Opportunities and Mirae Asset Emerging Bluechip.
3. Hot & Cold Sectors
For direct equity investors, buying individual stocks makes more sense, although risky. But, by combining some stocks, a portfolio approach can reduce risk to a great extent compared to one-two stocks only. The fortunes of market-linked products are connected to stock, sector performance. Healthcare, IT, Telecom have been star performers in the last one year period. Smallcaps, which tanked shortly after the COVID-induced market meltdown, have also recovered. Basic materials as a sector too haven’t done badly. In the coming days, sectors that did not participate in the rally may see more investor attention. PSUs, Infrastructure, Oil & Gas, Capital Goods, Realty, Metal, Power, Banking, FMCG, Finance, Consumer Durables are some of the hitherto underperforming sectors.
* Asset allocation stance
1. Dynamic asset allocation
For those who are unsure about whether to buy equities now and how much to buy, asset allocation products can work wonders. The fear of ‘buying high, selling low’ is real today because markets are ruling near all-time highs. Dynamic asset allocation funds enable frequent adjustments to the mix of asset classes to suit market conditions in such a way that positions in the worst-performing asset classes are cut while adding to positions in the best-performing assets. The popular dynamic asset allocation funds include HDFC Balanced Advantage, ICICI Pru Balanced Advantage, Kotak Balanced Advantage, L&T Balanced Advantage, DSP Dynamic Asset Allocation, etc.
2. Multi-asset allocation
You may want equity exposure, but not standalone. Hybrid products combine two or more asset classes. Multi-asset allocation funds are a class of hybrid funds that must invest in at least three asset classes. These funds typically have a combination of equity, debt, and one more asset class like gold, etc. These funds have lesser risk than most hybrid funds as the investments are spread across multiple asset classes. The biggest multi-asset allocation funds are ICICI Pru Multi Asset, Nippon India Multi Asset, UTI Multi Asset.
Heard of floating rate funds? These are funds that invest in financial securities which pay a variable or floating interest rate. So, the interest payments for the securities will not be fixed. These are called floating rate debt securities. The interest payments for these will fluctuate as per the prevailing interest rates.
The interest rate for the floating rate security will be based on a particular interest rate benchmark. There are many benchmarks used for floating rate securities. One of them is the MIBOR (Mumbai Interbank Offered Rate). The interest rate for the floating rate security that uses this benchmark will be the MIBOR rate plus a margin. So, every time the benchmark rate changes, the interest rate for the floating rate security is adjusted.
Floating rate funds or floater funds not only invest in floating rate securities, they could invest in preferred shares, corporate bonds, and floating rate loans of less than five years too. According to the Securities Exchange Board of India (SEBI) guidelines, floater funds are open-ended debt schemes that mostly invest in floating rate securities. The minimum investment in these securities needs to be 65% of the total assets managed by the funds.
Two of the top performing floater funds has given double-digit returns in the last one year. The topper in the list of floater funds, Nippon India Floating Rate, has provided investors with 10.9% in one year while Kotak Floating Rate Fund has given 10.5%. Here’s how floater funds have fared: the floater funds category has provided an average return of 8.73% in one year and 7.76% in the past three years. That’s the reason why debt mutual fund investors are interested in the floater fund category. Here are the details you need.
Types of floater funds
There are two common types of floating rate funds. One is short-term floater fund and the other is long-term floater fund. Short-term funds provide better liquidity to investors by investing in securities that have shorter duration.
How to invest in floater funds
You must choose floater funds that are right for your risk profile. These funds come with varying levels of risk across the credit quality spectrum. High yield funds might have lower credit quality investments and higher risks.
Advantages of floating rate funds
Floating rate funds provide investors with a higher interest income in a rising interest rate environment. As interest rates rise, the return from the floating rate funds increase. So, these funds appeal to investors when interest rates are set to start rising.
However, the best advantage with floating rate funds is that they are not highly impacted by interest rate changes. Debt funds that invest in fixed rate securities come with interest rate risks. Interest rate risk is the potential for investment losses because of changes in interest rates. So, debt funds that invest in fixed income securities are volatile and are impacted by interest rate changes. Floating rate funds come with a low degree of sensitivity to changes in interest rates.
Another point is that floating rate funds have very less duration risk. This is the risk of missing out on higher interest rates available in the debt market when interest rates rise. Since floating rate funds provide interest rates that rise with interest rates in the country, there is minimal duration risk.
Apart from the advantage of getting present interest rates and the lower sensitivity to interest rate changes, a floating rate fund helps you diversify your debt investments. Most of the time, investors hold only fixed income investments such as bonds and bank fixed deposits. Adding floating rate funds will provide diversification to the debt part of the portfolio. Another benefit is the affordability. Buying floating rate securities as a retail investor will involve higher costs and more capital. A floating rate fund will help you diversify your funds at a low cost and with a lower capital.
What about the credit risk of floating rate funds? Credit quality of these funds is more or less similar to that of liquid funds and ultra-short-term funds. So, one could say that they are safer than a credit risk fund or a dynamic bond fund.
You can get income from floater funds. These funds declare dividends that could be quarterly, semi-annual or annual. So, you get income and capital gains.
How are the funds taxed?
The taxation will be just as any other debt fund. If you hold the fund for less than three years, you pay short term capital gains. Long term capital gains and indexation benefit will be available oif you stay invested for three or more years.
