What a Floating Rate Fund Actually Does
Most debt funds hold bonds with fixed coupons. When interest rates rise, the price of those bonds falls, and so does the fund's NAV. Floating rate funds avoid most of that. They invest in bonds whose coupons reset periodically based on a benchmark like MIBOR or G-Sec yields. When rates rise, the next coupon resets higher. So the bond's price, and the fund's NAV, barely move.
That makes floating rate funds the cleanest available hedge for a rising rate environment. And yet AMFI numbers from April 2026 show the category at only about ₹51,700 crore in AUM across 12 schemes, small compared with about ₹6.4 lakh crore in liquid funds or ₹1.15 lakh crore in short duration funds (AMFI, April 2026). Most Indian retail investors have never heard of the category.
The SEBI Definition
SEBI's categorisation circular (latest version dated 26 February 2026, which renamed the category "Floating Interest Rates Fund") requires these funds to invest at least 65% of total assets in floating rate instruments, including fixed-rate bonds converted to floating exposures using interest rate swaps (IRS). The remaining 35% can sit in fixed-rate paper, money market instruments, or cash.
The actual benchmarks coupons reset against:
- MIBOR (Mumbai Interbank Offered Rate): the most common floating benchmark in India.
- 91-day or 364-day T-Bill yields: used for some PSU floaters.
- Reverse repo / RBI policy rate: less common, but used for select bank loans converted to securities.
Reset frequency varies by issue: monthly, quarterly, or semi-annually. The shorter the reset period, the closer the fund tracks current rates.
How much does a rate hike move a floating rate fund's NAV?
Modified duration in a floating rate fund is lower than its maturity suggests because coupon resets shorten the effective time to the next repricing. Figures below are from the SBI and HDFC floating rate and short term funds' factsheets as of 31 August 2026:
| Metric | Floating Rate Fund | Short Duration Fund |
| Yield (YTM) | 7.1%–7.6% | 7.6%–7.8% |
| Modified duration | 1.5–1.9 years | 2.3–2.4 years |
| NAV impact of 1% rate hike | Down ~1.5%–1.9% on reported duration | Down ~2.0% |
| NAV impact of 1% rate cut | Up ~1.5%–1.9% on reported duration | Up ~2.0% |
| Behaviour as rates rise over 12 months | Coupons step up | Locked at original yield |
Illustrative example, using the yields and durations in the table above. You hold ₹10 lakh. RBI hikes 100 bps over the next 12 months in 25 bps tranches:
- Floating rate fund: NAV barely moves; the running yield steps up roughly 80-90 bps over the period as coupons reset. End-of-year accrual closer to ₹72,000-75,000.
- Short duration fund: immediate ~2% NAV drop as the curve shifts; takes 6-9 months for the higher accruals to compensate. End-of-year total return closer to ₹50,000-55,000.
The reverse plays out in a falling rate environment. Short duration would deliver a one-time NAV pop. Floating rate would simply see future coupons reset lower. This is why floating rate is a tool, not a default holding.
When Floating Rate Earns Its Place
- You expect rates to rise meaningfully. If you genuinely believe RBI is at the start of a hiking cycle (high CPI, fiscal slippage, currency pressure), floating rate funds preserve capital while short and medium duration funds bleed.
- Mid-cycle uncertainty. When the yield curve is flat or you have low conviction either way, floating rate is the asymmetric bet: small downside if rates fall, real protection if they rise.
- Diversification within debt allocation. A 10-20% sleeve of floating rate alongside short duration / Banking & PSU smooths out total debt portfolio drawdowns through the cycle.
- HNI cash with 12-24 month horizon. Higher yield than ultra short, less rate risk than short duration. Useful for sizable parked balances.
When Not to Use Them
- Falling rate cycles. Once RBI clearly pivots to cuts, short and medium duration outperform meaningfully. Floating rate just clips falling coupons.
- Sub-12-month horizons. Money market or ultra short funds are simpler and have similar effective duration profiles.
- If the fund's actual portfolio is heavy on fixed-rate bonds with IRS overlays. Counterparty and basis risk can show up in stress periods. Read the fact sheet: pure floaters from PSUs and AAA corporates are simpler to underwrite.
- For small allocations under ₹1 lakh. The category complexity isn't worth the operational overhead at small ticket sizes.
Tax Treatment
No special treatment. Like other debt mutual funds, units bought on or after 1 April 2023 are taxed at your slab rate with no indexation and no long-term threshold. Holding for 5 years gives you the same tax treatment as holding for 5 months.
Worked numbers. ₹5 lakh in a floating rate fund averaging 7.0% over 18 months yields roughly ₹52,500 in accrued gains. At a 30% slab, tax of about ₹15,750. Post-tax effective return: about 4.9%. You hold the category for NAV protection during rate spikes, not for its post-tax yield.
How to Evaluate a Floating Rate Fund
- AUM. The category is small. Fund AUM above ₹2,000 crore is healthy. Below ₹500 crore, liquidity and concentration risks creep up.
- Actual floating exposure. SEBI requires 65% minimum, but check if the fund holds 70%+ in genuine floaters versus IRS overlays. Genuine floaters are cleaner.
- Modified duration. Compare it with peers: the SBI and HDFC funds reported 1.5–1.9 years in August 2026. A duration well above the category norm suggests more fixed-rate exposure.
- Credit quality. 80%+ in AAA / A1+ / Sovereign. PSU floaters and top-rated bank CDs are the bread and butter of well-run funds in this category.
- Expense ratio (Direct). Below 0.40% ideally. Some funds charge 0.6%+ which materially eats into yield.
- Top funds in the category: Aditya Birla Sun Life, Nippon India, ICICI Prudential and HDFC Floating Interest Rates Funds (renamed in 2026 under SEBI's new category names). AUM and rank rotate, so confirm with the latest AMC factsheet.
FAQ
How is a floating rate fund different from an ultra short duration fund?
Ultra short funds hold short-maturity fixed-rate paper. Their low duration comes from short maturities. Floating rate funds can hold longer-dated bonds with coupon resets. Their duration is low because of the resets, not the maturity. In a rising rate environment, floating rate captures the higher coupons over time; ultra short captures them via roll-over of maturing paper. Outcomes are similar in many cycles.
Is the yield really worth the complexity?
Honestly, in stable or falling rate regimes, no. The category outperforms specifically when rates rise unexpectedly. Treat it as a tool, not a base holding.
What's the catch with the IRS overlay strategy?
To meet the 65% floating threshold, some funds buy fixed-rate corporate bonds and overlay an interest rate swap to convert the cash flows. That introduces basis risk (the swap and the bond may not move in lockstep) and counterparty risk. Funds heavy on direct floaters from PSUs and banks avoid this complexity.
Can I SIP into a floating rate fund?
Yes. SIPs work cleanly given the smooth NAV behaviour. But the category pays off on timing: you want to be in it before rates rise, not averaging in after the cycle has turned.
Are these safer than gilt funds?
For credit, both are excellent. Gilts are sovereign; floaters are typically AAA / A1+. For interest rate risk, floating rate funds are far less volatile. Gilt funds can lose 5%+ in NAV during sharp rate spikes; floating rate funds barely move.
Where does floating rate fit in a 70/30 portfolio?
Within the 30% debt allocation, a 10-20% sleeve in floating rate (so 3-6% of total portfolio) is reasonable when the rate cycle is uncertain or biased toward hikes. The rest goes into short duration, Banking & PSU, or corporate bond depending on goal horizon.
Should you hold a floating rate fund?
Floating rate funds are not a default holding. They are a hedge against rising rates, and they do that job better than any other debt category. When RBI hikes 100 bps over a year, gilt and short duration holdings give back 2%-5% of NAV, while a floating rate fund's coupons reset higher.
The category is mid-sized (about ₹52,700 crore AUM in August 2026) and under-marketed to retail investors. Pick a fund with ₹2,000 crore+ AUM, a modified duration in line with peers (about 1.5–1.9 years in August 2026), 80%+ in AAA / A1+ / sovereign paper, and an expense ratio under 0.40% Direct. Use it as a 10-20% slice of your debt allocation when rates are biased to rise. Skip it when RBI is clearly cutting. Tax is at slab rate, the same as every other debt fund.
Run your numbers: compare a debt fund with a bank deposit using the FD and RD calculator, and if you plan regular withdrawals, see how long the money lasts with the SWP calculator. For a one-time investment, use the lumpsum calculator.
Run your numbers: to see whether a floater beats a bank deposit after slab tax, put the same amount through the FD and RD calculator. Parking a lump sum for 12-24 months? The lumpsum calculator shows what it grows to, and the SWP calculator shows how long it lasts if you draw from it monthly.