NFO review: UTI Floater Fund launches to take advantage of rising interest ratesWith yields moving up over the last 12 months, the prices of fixed income instruments have moved down. This has resulted in relatively lower return for investors in debt funds. Average one-year returns of credit risk funds are less than 4%. Corporate bond funds have given 3.5%. Dynamic bond funds have generated less than 2%.

Medium duration and long duration debt funds haven’t fared well. However, liquid funds – which invests in shorter duration instruments – have more or less been steady. But liquid funds are not exactly an investment; they are more of a parking slot for your money. What if there was really another way to take exposure to debt asset class through mutual funds?

On October 12, UTI Mutual Fund launched a new fund offer (NFO), UTI Floater Fund. The NFO will close on October 26, while the scheme will re-open on October 31 for investment at the prevailing Net Asset Value.

Floating rate instruments

A floating rate fund is a fund that invests in fixed income instruments paying a variable or floating interest rate. It invests in bonds and debt instruments whose interest payments fluctuate with an underlying interest rate level, as opposed to paying fixed-rate income.

UTI Floater Fund will invest predominantly in floating rate instruments (including fixed rate instruments converted to floating rate exposures using swaps/derivatives).

Floating rate instruments are a different avenue to capture debt returns. These instruments are issued by corporates. The unique thing about them is that they have a periodic reset of coupons in line with reference rate (like 1-month or 3-month Mumbai Interbank Offer Rate). The coupon reset is periodically done viz. monthly, quarterly or annually. The instruments usually have one month to five years maturity.

Benefit of floaters

Floating interest rates have two major benefits. Firstly, it is an alternative that pays a spread above current short-term rates and also enjoys the benefit of future rate increases. Think of it like the home loan EMI you pay. When the interest rate rises, the EMI also shoots up. Secondly, floating instruments have a limited sensitivity to interest rates. A floater’s coupon rate changes when market rates change. UTI Mutual Fund says that a floater’s price will fluctuate lesser than fixed-rate bonds of similar maturity.

There is a market for Floating Rate Instruments (FRIs) in India. Issuance of FRIs has been growing over the last few years.

Fund USP

The UTI Floater Fund aims to act as a potential hedge against rising interest rate & inflation. It will be a diversification within the different segments of the debt market. As for the fund strategy, it will attempt to maintain an average maturity of 1 to 3 years, just like a short duration fund. But where this fund is different is the predominantly floating rate type of instruments being invested in. In terms of rated instruments’ allocation, UTI Floater Fund would look at investing 40-70% in AA plus and AAA bonds. The rest (30-60%) would be in AA or AA minus below rated instruments.

There is no entry or exit load. The fund benchmark is CRISIL Ultra Short Term Bond Index.

Peers

Using floating rate instruments to get returns is not new. The trend started from way back 2001. Today, there are six funds and the one from UTI would be the seventh. One year returns have ranged between 4-6%. Three-year returns range from 6% to 8%.

Fund name Launched Exp Ratio (%) 1-Year 3-Yr 5-Yr 10-Yr Since incptn
Aditya Birla Sun Life Floating Rate Fund-LT 01-06-2003 0.39 6.4 7.81 8.46 8.6
Franklin India Floating Rate Fund Growth 23-04-2001 0.95 6.34 6.17 6.35 5.98 5.83
HDFC Floating Rate Debt Fund – Wholesale 23-10-2007 0.38 6.31 7.55 8.27 8.08 8.17
DHFL Pramerica Floating Rate Fund – Growth 09-10-2009 0.58 5.86 7.15 7.88 7.87
ICICI Prudential Floating Interest Fund – Growth 17-11-2005 1.3 5.65 7.31 7.95 7.91 7.93
Reliance Floating Rate Fund – Growth Plan 27-08-2004 0.6 3.72 6.6 7.71 7.7 7.53

Fund managers

Amandeep Chopra and Sudhir Agrawal.

Taxation

Like any other debt fund, this floater fund will be more tax efficient than a fixed deposit in a bank. This is because investments held for more than 36 months will benefit from indexation. Imagine you put Rs 1 lakh in a debt fund for three years and a similar amount in traditional saving instruments. The post-tax return in case of a debt fund would be 150-200 bps more typically for an investor in the highest tax bracket.

RupeeIQ take – Investors, who are reluctant to lock in at the current fixed rate for a long horizon, can consider this fund. Interest rates are sure to trend upward in the future. So, the resets in floaters should help. However, the historical returns in this category have not been that great. Floater funds are best-suited as a means to diversify. Unless there is that excitement like in Jul-Aug 2013 period when floater funds gave 9-10% in a year, a 5-7% return may be expected from them in ordinary times. It is up to the individual fund managers to deliver better returns than peers. We also believe that the expenses of all floater funds are a key metric to be monitored. A few funds already charge 1-1.3% expense ratio for these debt funds.

Disclaimer: Please note that investors are requested to consult their financial, tax and other advisors before taking any investment decision.