MF-Query Board

I am thinking of investing in floating rate funds for the debt part of my portfolio. However, should I consider ultra-short duration funds given the present market scenario where the interest rates are in an upward bias? - Neeraj Chopra 

Floating rate funds are Debt Funds that must invest a minimum of 65 per cent of their portfolio in floating rate instruments. These funds provide considerable diversification, thereby reducing the overall portfolio risk. Furthermore, investing in floating rate funds reduces duration risk, which is the risk of loss due to an increase in interest rates in the current market when investors have already invested in longer duration fixed income securities. So, when the interest rates are rising, your investment in floating rate funds offers lower duration risk as compared to longer term fixed income instruments.

Also, the reverse can happen in a falling interest rate scenario. The open-ended nature of a floating rate fund gives investors more flexibility in terms of entry and exit and the time of staying invested with an expense ratio ranging from 0.22 per cent to 1.32 per cent. Floating rate funds are linked to the benchmark interest rates and therefore in a rising rate environment investments in these funds can generate returns higher than the fixed income securities. Whereas the reverse can happen and when the interest rates fall, these funds can give lower returns than the traditional fixed income securities. 

As per the regulations stated by the Securities and Exchange Board of India (SEBI) 65 per cent of the fund’s portfolio is invested in floating rate instruments. The remaining 35 per cent is invested in fixed rate debt instruments. Hence, it is very crucial to know and understand what the balance 35 per cent of the portfolio holds because sometimes the fund manager, in order to generate better returns, might invest in lower-rated bonds, which could expose the entire fund to credit risk. Floating rate funds are most suited in a rising interest rate scenario because the interest rate on underlying bonds would tend to be reset to higher levels, thereby acting as a hedge to rising interest rates which would tend to negatively impact fixed rate bonds or the bonds on which the interest rates are fixed. 

To conclude, when it comes to the debt portion of your portfolio, floating funds offer diversification in a rising interest rate scenario and at the same time these funds have credit risk. However, the supply of floating rate bonds is limited. Only about 5 per cent of the total outstanding corporate bond issuances in the Indian debt market are of floating rate nature.

To take your query further, ultra-short duration funds are openended debt mutual funds. The securities in this fund’s portfolio have a maturity period of 3-6 months. Money market instruments or fixed income securities like commercial papers and certificate of deposits with maturities below six months are included in this portfolio. Moreover, these provide reasonable returns with sufficientliquidity. The securities have low maturities, which makes the fund less sensitive to market movements. Generally, this fund is suitable for those who want to park their excess funds for up to six months. To conclude, investing only because the interest rates are expected to rise may not be the best idea. 

A majority of retail investors should avoid tactical allocations. It is rather preferred to stick to an asset allocation that is consistent with your financial objectives. Most retail investors’ debt allocations are best served by liquid, ultra-short-term funds, and even fixed deposits. These will help protect capital while also meeting liquidity requirements. A rising interest rate situation benefits floating funds. However, because of the scarcity of floating rate bonds, these funds have a liquidity risk. As a result, for your debt allocations, stick to the tried-and-true ultra-shortterm and liquid funds.

Which is the best small-cap fund to invest for 10 years? - Rajesh Das

Small-cap mutual funds are typically equity mutual funds wherein the fund manager allocates almost 80 per cent of the scheme’s money into small-cap companies. According to the Securities and Exchange Board of India (SEBI), small-cap companies are those companies that have a total market capitalisation of less than `500 crore and are ranked below 250th on the stock exchanges. These companies are generally in their growth phase or are streamlining their small business by trial testing their products and giving more preference to their research and development process. Hence, these companies can become very successful in the coming years if everything goes well or they cannot if things take a turn for the worse and are not able to give sufficient returns on investments to their investors.

As such, they fall into the high risk and high return category. If the markets fall, these small-cap funds have the most to lose. From an investment perspective, small-cap funds are more preferred by risk-loving individuals who have a high risk tolerance appetite even if their investments fall over more than 50 per cent. Hence, small-cap funds are also beneficial if one is looking for a longer period of investment of say around 8-10 years. Most of the times, if selected properly, these funds can add a lot of value to one’s portfolio. Following are some of the best performing small-cap mutual funds that are suitable for an investment period of 10 years.