We all know that markets are highly dynamic in nature. So, why shouldn’t our investment options also be the same? Luckily we have dynamic bond funds to cater to this need.
What are dynamic bond funds?
Dynamic Bond Funds belong to the category of debt funds. As per SEBI guidelines, these open-ended debt funds have the flexibility to invest across varying durations. They can invest in short-term bond funds in one month and long-term in another, basis the direction being followed by market interest rates.
Dynamic bond fund investments are taxed as per other debt funds. If the holding period is three years or more, the returns are taxed as Long-Term Capital Gains (20% tax rate with indexation benefit). Short-term capital gains (if the investment is redeemed before three years) are added to overall income and taxed basis the applicable income tax slabs.
How do these debt funds work?
Dynamic Bond funds seek to generate higher returns by switching between varied durations basis the market conditions. Bond prices and interest rates are inversely related to each other. When the interest rates go down, bond funds with longer durations get rewarded handsomely. However, in case the interest rates climb up, these funds stand to lose out a lot. Fund managers in charge of dynamic bond funds can reduce the duration (when interest rates are going up) to soften out the blow from dwindling bond prices. Similarly, they can increase the duration of the underlying investment so as to capitalize on the rising bond prices.
Hence, if you invest in dynamic bond funds, your debt funds risk is managed and the potential for earning higher returns is also enhanced.
Factors impacting the success of dynamic bond funds
- Performance
What do you do before making any online purchase? Read the reviews to see how the product has fared for others. Similarly, before you invest in dynamic bond funds, you should analyze the performance (in absolute terms as well as in relation to benchmark and peers) for a period of at least 3 to 5 years. Going by just the last year’s performance scorecard is likely to result in wrong choices.
- Fund House
If you wish to invest in dynamic bond funds, then you need to choose a fund house with a healthy track record. Factors such as technical research, market knowledge and understanding and agility to respond to changing market conditions play a crucial role in maximizing the returns as well as managing the debt funds risk.
- Fund Manager
Dynamic Bond Funds are reactionary in nature. The success of these funds relies heavily on the fund manager’s ability to catch the troughs and peaks of the interest rate cycle and change the duration accordingly.
Risk in dynamic bond funds?
Debt funds generally have lower debt funds risk quotient and are considered suitable for conservative investors. However, those who are looking at investing in dynamic bond funds need to have a healthy risk appetite. This is because sometimes the trend (for interest rates) is not clearly visible. There are times when the fluctuations (up as well as down) happen very swiftly (too fast for even the best fund managers) and these debt funds get hit severely.
Best of the lot
If you want to invest in dynamic bond funds, you should consider these top-performing schemes:
- ICICI Prudential All Seasons Bond Fund
- Edelweiss Dynamic Bond Fund
- Mirae Asset Dynamic Bond Fund
- Kotak Dynamic Bond Fund
- Aditya Birla Sun Life Active Debt Multi Manager FoF Scheme
- Quantum Dynamic Bond Fund
- Tata Dynamic Bond Fund
- Quant Dynamic Bond Fund
- IDFC Dynamic Bond Fund
- L&T Flexi Bond Fund
Final Words
Dynamic Bond funds need to be given a minimum of three years (five years for optimum results) to get the most out of your investment. A value research study revealed that at the 3-year time juncture, the outperformance of dynamic bond funds (over short-term funds) was around 60%-70%. The figure jumped to 80%-90% at the five-year time frame.
Invest in dynamic bond funds if you have the appetite for higher debt funds risk and hunger for higher returns!
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