Floaters adopting the 'synthetic' way

Are floater instruments really based on floating rate instruments? The variation in the ratio of amounts invested in floating rate instruments of the total investible corpus is as wide as between 0 per cent to 73 per cent.

There are currently 23 floater schemes in existence, with assets of Rs 15,000-odd crore under management. But the number of floating rate instruments in the market are limited.

The stock of floating rate instruments issued by the government stands at around Rs 46,000 crore. The markets have not kept a tally of the stock of floating rate instruments issued by corporates but the total amount is not expected to be large.

Most of the floating rate funds actually use 'synthetic floaters' made up of instruments which take on the features of floating rate instruments under some circumstances, or mostly invest in the call money market, which is technically a floater since its price is adjusted every day.

So a scheme such as the JM Floater long term, has around 78 per cent put in the cash, call and repo market. The proportion of floating rate instruments in funds' portfolios vary between 0 per cent and 85 per cent.

What most funds do is to invest largely in fixed instruments and then do swaps in the overnight indexed swap (OIS) market. These are called synthetic floaters.

It works in the following way: suppose a floating scheme has invested in a fixed deposit at the rate of six per cent.

The fund manager then approaches the OIS market where he swaps this fixed rate for an overnight Mibor-based floating rate, at Mibor plus 50 basis points, say. At present, the five-year OIS is at 6.30/ 33 per cent.

Sandesh Kirkire, head of debt funds at Kotak Mutual Fund, said, "this is an acceptable practice and there is nothing wrong with it."

Ashish Agrawal, vice-president, debt segment in DSP Merrill Lynch said that counter-party and basis risks are the main risks in this kind of a transaction. Further, the counter-party to the original swap and the counter-party to the reverse transaction may not be the same - so this may also pose a risk.

Floaters, the first of which was launched in February 2002 and the most recent one in August 2004, have posted returns ranging between 0.48 per cent and 6.18 per cent, on an annualised basis. Against this, the NSE Mibor has returned 7.21 per cent annualised. Raj Raman, marketing head at Pru-ICICI Mutual Fund said that a lot of money has been coming into floaters.

In fact, both during August and September, it was floaters which saw the most inflows, even more than in equity schemes.

Spreading risk

• The variation in the ratio of amounts invested in floaters of the total investible corpus is as wide as between 0 per cent to 73 per cent
• There are currently 23 floater plans, with assets of Rs 15,000-odd crore under management.
• Most funds invest largely in fixed instruments and then do swaps in the overnight indexed swaps market. These are called synthetic floaters
• The first floater was launched in February 2002 and the most recent one in August 2004
• Floaters have posted returns ranging between 0.48 per cent and 6.18 per cent, on an annualised basis, compared with 7.21 per cent by NSE Mibor