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Floating rate funds: A good buy in rising interest rate scenario

What is a floating rate fund? These are the debt mutual funds which invests about 75% to100% in securities which pay a floating rate interest (bank loans, bonds and other debt

securities) while the rest is in fixed income securities. The primary advantage of these funds

is that they are less volatile than other types of debt funds. This advantage arises due to the

inherent structure of the floating rate bonds.

Floating rate funds vary from conventional fixed rate investments mainly on the basis of

coupon rate i.e. the coupon is revised at regular intervals (i.e. floating) with respect to changein the benchmark rate. Consequently, if there is a rise in the interest rate, the coupon rate

usually reflects this change, thereby securing the interests of investors during rising interest

rates. Usually investors turn to these funds when they look for safety for their investments.

Interest rates have been rather unpredictable and specifically, they have been on the rise in

recent times. Crude prices have risen and so has the inflation. The Reserve Bank of India

(RBI) raised the repo rate by 25 basis points (bps) to 6.75% recently. With the volatility in

government securities/bond prices over the last few weeks, investors seek safe haven fortheir investments in floating rate funds.

Many investors perceived income and gilt funds as "very safe" investments providing steady

returns. However, it is only increasing volatility in the bond market which highlights the risk

of investing in debt funds. Considering the fact that not a single long term floating rate fundhas slipped into the negative terrain suggests that the performance of the floating rate funds

have been quite good. Investors looking for capital preservation during times of rising

interest rates cannot afford to ignore floating rate investments. However, they must note that

while floating rate funds do well in a rising interest rate scenario, when the scenario turns(i.e. interest rates fall), floating rate funds underperform their fixed rate counterparts. So it's

advisable to have a debt fund portfolio with adequate allocation for various categories so thatinvestors are well placed to benefit from various phases of the interest rate cycle.

DNA Money Scheme Selection Methodology:From the universe of funds, we have confined ourselves to open ended floating rate funds

having a Quarterly AAUM greater than the median of the category. The median AUM underthe scheme was Rs 31.64 crore as on March 2011. (Latest available Quarterly AAUM). As

for the analysis, the funds have been chosen on the basis their Expense ratio. In addition to

the aforesaid criteria the Sharpe ratio of the schemes has also been taken into consideration.Expense Ratio: A measure of determining the costs an investment company has to bear to

operate a mutual fund. Lower the ratio the better it is. Expense ratio matters especially in

case of debt funds.

Scheme Name 1

Month3

Months6

Months1 Year 3

Years5 Years

Birla Sun Life Floating

Rate Fund - STP -

Growth

8.69 8.82 8.32 7.26 6.70 7.07

HDFC- FRIF- LTF- 7.68 10.50 9.02 7.04 7.82 7.78

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Growth

Canara Robeco FRF -Growth

9.52 9.80 9.21 7.81 7.07 7.46

Crisil Liquid FundIndex

7.80 7.81 7.82 6.94 6.19 6.52

Returns as on 4th June 2011.

Birla Sun Life Floating Rate Fund - STPGrowth:

Launched in June 2003, with an aim to generate regular income through investment in aportfolio comprising substantially of floating rate debt / money market instruments. It has

more than 99% of the allocation in cash holdings.

Looking at the investment strategy, the scheme has invested in high quality bonds which are

the safest bets. This conservative approach has helped the fund to generate positive returnseven when the market plunged in 2008. The scheme fetched 6.02% and 7.07% returns

compounded annually for 2 year and 5 year period respectively, while its benchmark stood at

5.01% and 6.52%. Having a lower expense ratio has also been favorable for the fund.

Canara Robeco Floating Rate Fund- Growth

The fund has been in existence since March 2005 and is managed by Suman Prasad and

Akhil Mittal. The scheme aims to generate income and capital appreciation by mitigatinginterest rate risk through investment in debt and money market securities. It has invested in

CDs and CPs of high quality. The scheme has delivered higher returns than its benchmark

index across various time horizons. It fetched 9.52%, 7.81% and 7.46% returns for 1month, 1year and 5 years time frame while its benchmark was placed at 7.80%, 6.94% and 6.52%

returns. Since its launch, the fund had generated 7.22% returns compounded annually.

HDFC- Floating Rate Income Fund-LTF- Growth

The fund can definitely boast of having the highest corpus in the category. Managed byShobhit Mehrotra and Anand Laddha,the scheme aims to generate regular income through

investing atleast 75 per cent of its assets in floating rate debt / money market instruments orfixed rate debt / money market instruments swapped for floating rate returns, and up to 25

per cent in fixed rate debt / money market instruments. The scheme is suited for investors

having a relatively longer holding period. The scheme has placed its bet on high quality

papers and bonds. The scheme has allocated more than 95% allocation in cash holdings. Onthe performance front the fund has generated 7.68% and 9.02% simple annualized returns for

1 month and 6 months tenure. Since the launch of the fund in January 2003 the fund has

delivered 6.62% CAGR return. It has the lowest expense ratio in the category of 0.01%.

Ideally floating rate funds suit those investors who have a lower risk appetite as there is not

much price volatility. These are good to buy in a rising interest rate scenario.