NFO review: Tata Floating Rate Fund to tackle rising interest rates

This is a new open-ended debt scheme predominantly investing in floating rate instruments including fixed rate instruments converted to floating rate exposures using swaps/derivatives

Staff Writer   /   June 22, 2021

Tata Mutual Fund has launched a new debt scheme: Tata Floating Rate Fund. This category of debt funds has now seen some launches with DSP and IDFC also having unveiled their respective products within a span of a few months. Given the possibility that interest rates have peaked, there is a fear that traditional debt funds, which usually take hard bets on rates, can now face NAV losses if rates are hiked up slowly. Floating rate instruments can do better than them. Tata Floating Rate Fund’s New Fund Offer (NFO) opened on June 21, 2021 and will close on July 5, 2021. Here are all the details.

What is this fund

The fund will endeavour to generate relatively stable returns through a portfolio comprising substantially of floating rate debt, fixed rate debt instruments swapped for floating rate returns and money market instruments.

The fund aims to invest a minimum of 65 per cent of its corpus in floating rate securities issued by corporates or the government or convert fixed interest securities to floating via derivatives. This is pretty standard across all floating rate debt funds.

A floating rate fund means that the fund’s broader direction moves in tandem with interest rate movement. Floating rate funds invest in either floating rate instruments (instruments whose yields change with change in benchmark rates) or in fixed coupon instruments which are converted to floating rate by using swaps.

How it works

In case of floating rate instruments, as the broader interest rates change, the benchmark also moves, resulting in similar direction movement. E.g. If the fund buys a paper with coupon of MIBOR + 200 bps. MIBOR tracks very closely to operating rate (repo or reverse repo). Now if repo or reverse repo is hiked by 25 bps, MIBOR would also go up by 25 bps. That means the fund will have higher coupon from its holding. This is unlike a fixed coupon bond, where the coupon will not change with change in repo or reverse repo change.

Floating rate fund means that the fund’s broader direction moves in tandem with interest rate movement. In case of fixed income instruments where swaps are used to convert them into floating, the swaps generally move in similar direction as broad interest rate movement. E.g. if the fund buys a 3 year NCD with 5 per cent fixed coupon. The fund then pays fixed swap against it (assume 3 year swap ). If the repo rate changes, the swap rate will also go up. So, the fund will make profit on the swap paid position, which would offset the loss that the fund incurs on the fixed coupon bond. Hence, rate move will have lesser impact as compared to a case where a fund holds the fixed coupon bond and rate goes up.

In both the above cases, the direction of fund is similar to direction of rate movement. Given Tata MF’s view on interest rates, this fund provides flexibility and self-adjusting to changing rate environment. Floating rate fund also gives the flexibility to not only manage interest rate risk through changing allocation to debt instruments (buying different tenure or duration papers), it also provides us another tool in form of swaps to manage duration and at same time choose the optimal mix. Overall, one has the flexibility move the fund positioning with changing attributes or dynamics of the market.

Fund-house speak

Akhil Mittal, Senior Fund Manager at Tata Asset Management explains the rationale behind launching Tata Floating Rate Fund. “If we look at overall interest rate cycle, with inflation remaining high, we believe the easing cycle is behind us and what follows is normalization of policy. RBI will most likely reduce the excess accommodation and would address liquidity and rate corridor (difference in reverse repo and repo) first and follow up with rate movement as and when required. RBI will stay put on current accommodation for this FY, and any sort of normalization will start only after 6-9 months.”

In line with this view, Tata MF expects reverse repo to remain the operating rate (liquidity to remain systemically surplus) and reverse repo to gradually rise and come back to normal band of 25bps below repo rate from current 65 bps below repo rate.

A floating rate fund in the debt category should suit the upcoming rate cycle and would provide a good alternative to other debt funds / products, adds Mittal.

NFO details

Dates: Opened 21st June 2021 and closes 5th July 2021

Fund Manager – Akhil Mittal

Benchmark – CRISIL Ultra Short Term Debt Index

Minimum investment amount- Rs 5,000

Load – Nil

Why invest

A floating rate fund is suitable in a rising interest rate and short term investments. As the coupon is predominantly aligned to shorter term rates, the fund provides relatively lower interest rate risk.

Who should invest

Investors seeking relatively stable portfolio yields in a rising interest rate scenario can opt for floating rate funds.

Those investors seeking diversification of Fixed Rate investments can also consider.

Also, investors preferring shorter duration enhanced accruals with lower interest rate risk can go for this category.

What are the risks

A floating rate fund’s returns will be influenced by the accrual income of the fund and the mark to market gains/losses on the fund positions.

The fund portfolio will have a mix of debt securities from quality issuers however, the credit risk may still prevail.

The fund may run a moderate interest rate risk (scheme may have interest rate risk between Low Duration to Short Term Duration Funds).

There are mark to market risk and liquidity risks. Since the fund would focus on quality issuers which will help alleviate the Credit and Liquidity risks in the Fixed rate portfolio. The OIS trades, however, will have lower counter party risk and adequate liquidity.

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