Floating Rate Fund: Meaning, Benefits, Risks and How It Works

Key takeaways 
 

• In a floating rate fund, the interest rate often changes according to the market conditions. 
   
• It helps investors to control or manage risk by changing portfolios.
   
• Fixed coupon rates are sensitive to interest rates while floating rate funds are not. 
   
• Floating-rate funds are secured. It provides good returns. These funds are the best option for those who don't want to take risks.

Suppose you bought a home, it was your dream, and you did it after getting a job. You applied for a home loan, and it was approved. When you applied that time, the EMI interest rate was 7%. But after nine months, the Reserve Bank of India increased the rate by 1%. As a result, your EMI became 8%. Now you have to pay a higher interest rate. Similar in this way, floating rate funds work. 

What is a Floating-rate fund?

When you invest in the debentures, it carries some risks like internet risk, liquidity risk, and credit rate risk. 

Interest rate risk 

This risk is the risk of change in market price of debentures because of interest rate change.

Liquidity risk

When you need money but can't withdraw it, this situation comes under liquidity risk.

Credit risk

When there is a default on repayment by the issuer of a debenture. 

According to the SEBI guidelines, a floating rate fund is a fund which invests a minimum 65% of its in floating rate bonds. In a normal bond, you receive fixed interest payments in regular intervals. In floating rate bonds, the interest you receive is not fixed. These rates are often connected to the various benchmarks like G-sec, MIBOR(Mumbai Interbank Offer Rate), or REPO. When these benchmarks change, your receivable interest rate also changes. If the benchmark rate increases, you get a higher return, and if the benchmark rate decreases, you get a lower return. 

Examples of floating rate funds

Floating rate debt fund, Invesco senior floating rate fund, Nippon India floating rate fund, ABSL floating rate fund.

Why is a floating rate fund a good option to invest in?

We know that investing in debentures can be risky. If you invest in a debenture today, you will receive lower interest on the debenture for the entire future. It is possible that this interest rate is lower now and will likely rise in future. This means new bonds issued later will earn higher interest. So the bonds issued currently become less attractive. It is similar to the FD. Like, you invest in an FD now, but after a few months the rate of interest increases and the new FD gives a higher interest rate. 

If you invest in floating rates, your interest also increases as the benchmark increases. As a result, you get a higher return. In this situation, investing in regular debentures can lead to a negative or lower return. But at a floating rate, there is no such risk. 

Bonus tip - The Reserve Bank of India (RBI) in March 2026, repo rate is sitting at 5.25% and according to the projection, inflation will stay low at 2%. This means, if float funds give 7.8% and inflation is 2%, your real return will be 5.8%.