DSP Floater Fund NFO: Should you invest?

The open ended debt scheme will predominantly invest in sovereign bonds and overnight index swaps

Staff Writer   /   March 8, 2021
DSP Mutual Fund

DSP Investment Managers Private Limited has launched DSP Floater Fund, an open ended debt scheme predominantly investing in sovereign bonds and overnight index swaps (OIS). The fund is aimed at helping investors better navigate interest rate cycles.

The scheme is suitable for investors who seek a low risk alternative, with a minimum holding period of over 1 year. The portfolio is expected to carry very low credit risk.  

The NFO, which is open now, will close on March 17, 2021. Read on to know more.

What is a floater fund

Floater funds are a type of an open-ended debt scheme. These funds predominantly invest in floating rate instruments (including fixed rate instruments converted to floating rate exposures using swaps/ derivatives).

Interest rates have more or less bottomed. This means rates will not get much cheaper. So, rates should rise slowly. When interest rates rise, debt funds NAV are impacted negatively.

A floater fund has the potential to gain from fall in interest rate as well as shield portfolio returns in times of reversal of interest rate cycle.

DSP Floater Fund

The scheme will allocate a minimum of 65% and a maximum of 100% in floating rate debt securities and have exposure mainly in Sovereign Securities issued by state and central government and OIS for creating synthetic floating rate exposure. The scheme also proposes to invest up to 35% in fixed rate debt securities including money market instruments.

OIS or overnight indexed swap is an interest rate swap over some fixed term where the periodic floating payment is generally based on a return calculated from a daily compound interest investment. An interest rate swap is a forward contract in which one stream of future interest payments is exchanged for another based on a specified principal amount.

The fund aims to curate a construct between

• Sovereign securities –
– G-Sec / SDLs with maturity between 2 – 6 years (State Development Loans or SDLs are sovereign securities issued by various State Governments to raise funds from the market at market determined.
– Roll down strategy in Sovereign position with buy & hold approach

• Paid position in Overnight Index Swap (OIS)
– Tenure of contract ranging from 1 month to 3 years.

Starting point of fund construct will be determined by the spreads between these two segments.

The fund will have 3 drivers of returns.

1. Movement in G-Sec yield – This will be determined by demand supply of G-Sec bonds.

2. Movement in OIS yield – This will be determined by outlook on benchmark rate (repo) resets

3. Movement in overnight rates – This will be determined by existing liquidity conditions.

Current investment strategy

DSP Floater Fund will seek to invest in

• Government Security
– 4 Year G-Sec rolling down up to 12/24 months.

• Paid OIS position (Synthetic floating rate exposure)
– Contract bearing maturity of 2 / 3 years

The proportion between G-Sec and paid OIS position to be maintained at 1:1 which may reduce to 1:0.7

The roll down component in 4 Year G-Secs aims to provide stable / predictable accruals with periodic reduction in duration.

The paid position in 2 / 3 year OIS hedges risks of reversals in rate cycle + add to accruals as the liquidity tightens.

The combination of 4 Year G-Secs + 2/3 year paid OIS position will reflect in a lower maturity profile (~2 years) for the fund which will keep reducing every passing quarter.

Do note that the spread (difference) between 4 Year G-Sec and 2 year OIS tends to compress through the period of reversal of interest rate cycles. Currently, spreads are trading at considerably higher levels than its historical average.

When can fund outperform, underperform

Outperformance will be a function of spread compression between 4Y G-Sec and 2 Year OIS holdings.

Underperformance will be a function of spread widening between 4Y G-Sec and 2Y OIS exposure. Spread widening can happen when the government announces higher borrowing and RBI supports through higher liquidity.

In a rising interest-rate cycle, as and when yields rise, the floater fund’s G-Sec exposure will be subject to capital losses. Rising interest rate scenario will also imply eventual rise in OIS yield generating capital gain in OIS position. Rise in OIS levels in a higher proportion (to rise in yields of government securities) can bridge the gap in yields between GSec and OIS. This will enable the fund to generate return in a rising rate scenario.

In a falling interest-rate cycle, as and when yield falls, the floater fund’s paid OIS position will be subject to capital loss. Falling interest rate scenario will also imply eventual fall in G-Sec yield generating capital gain in G-Sec position. Fall in G-Sec yield in a higher proportion (to fall in yields of OIS) can bridge the gap in yields between G-Sec and OIS. As G-Sec component bears higher maturity, this exposure will enable the fund to generate return in a falling rate scenario.

Other details

Minimum application amount (Fresh purchase) – Rs 500 and any amount thereafter

Exit Load  – Nil

Fund Manager – Saurabh Bhatia

Fund-house speak

“Roll down funds have been a preferred choice for many investors in the 3 years. DSP launched its own roll down fund – Corporate Bond Fund when rates were high (9%) in 2018. As the interest rate cycle shows signs of reversal, we felt it is a good time to introduce a roll down sovereign (short term) fund with OIS that helps hedge against the interest rate risk. The attempt is to capture the term spread at 5 years but minimise volatility if interest rates rise,” says Kalpen Parekh, President, DSP Investment Managers.

Conclusion

DSP Floater Fund is a product in the short term category (duration band of 1 to 4 years) with interest rate hedge using paid position in OIS.

The scheme aims to offer relatively stable returns for investors without worrying about changes in interest rate cycles. The scheme aims to navigate interest rate cycles in an optimal manner, having the potential to gain from fall in interest rates as well as aiming to shield portfolio returns in times of reversal of the interest rate cycle.

The scheme has elements of active and passive fund management, having active management in paid OIS positions with the passive roll down strategy in Government Securities and State Development Loans.

The scheme is suitable for investors who seek a low risk alternative, with a minimum holding period of over 1 year. The portfolio is expected to carry very low credit risk.  

In the last one year, floater funds as a category have seen a maximum 8.3 per cent return and a minimum 4.7 per cent return. We looked up the 1-year rolling return of some of the biggest and oldest floater funds using 10 years – we saw a median 1-year rolling return of about 8 per cent.

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