What is a floating rate mutual fund?

In th debt category of mutual funds, one important variety is Floating Rate Mutual Funds.

Objective

To provide stable rate of return without much volatility arising out of interest changes.

How it works?

Unlike a typical debt fund which buys a govt security or a corporate bond at a fixed rate of return, floating rate funds invests in debt instrument which offers a variable rate of return depending on the interest rate in the market.

Eg. A debt fund would invest in a govt sec giving a return of 6%. When the interest changes to 8%, the govt sec would still give you only 6%. However a floating rate debt instrument will adjust its return to 8% as per the inflation rate in the market.

When it works well?

It works well in an increasing rate scenario as what had happened in last 2-3 years. When you invest in a floating rate fund when interest rate is at 6% and when it increases to 8% in a year, you stand to get benefited.

However in a falling rate scenario, you would lose your return on your investment.

Who should buy?

People who want to leverage the interest rate changes in a increasing interest rate scenario.