What Are Dynamic Bond Funds

Usually, the performance of debt funds varies with the changing interest rates. As interest rates increase, the returns drop in debt funds, whereas the debt fund earns good returns in a falling interest rate cycle. On the contrary, the Dynamic Bond Funds are a class of debt mutual funds that ‘dynamically’ manage the lending duration taking advantage of fluctuating interest rates and benefiting from rising and falling interest-rate cycles. We have covered essential factors of Dynamic Bond Funds in this article that you need to know about them before investing.

What are dynamic bond funds?

As per SEBI, dynamic bond funds are those open-ended debt schemes that invest across duration. Dynamic bond funds are dynamic in terms of the composition and maturity profile. These schemes have the potential to generate higher returns by shifting duration based on market scenarios.

Dynamic bond funds’ objective is to earn ‘optimal’ returns in both rising and falling market scenarios. These funds usually have huge assets under management (AUM). However, the schemes may suffer if the duration call by the fund manager goes wrong.

How do Dynamic Bond Funds earn?

These bonds’ performance majorly depends on the fund manager’s decisions and how he manages the portfolio. These funds are constructed to allow fund managers to use interest rates movements prevailing in the economy by altering their portfolio allocations between long-term to mid-term to short-term bonds and generate higher returns. Fund managers either increase or decrease the lending duration depending on whether the interest rates are heading down or up. It allows the fund to generate steady returns regardless of the interest rate cycle.

Sometimes, there could be a long gap between interest rate changes, which hit investors’ income. So, these funds are an excellent alternative for those who want to ride the interest rate cycles. Thus, it helps to iron out the ‘rate-waves’ more efficiently.

Who can invest in dynamic bond funds?

These funds are ideal for investors comfortable with moderate risk appetite and an investment horizon of at least 3-5 years. Investors who are also not experts to make the right calls based on the interest rate movement can invest here.

Important Factors of Dynamic Bonds

1. Role of Fund Manager

The fund manager’s viewpoint of interest rate is exceptionally crucial as the fund’s performance depends on the fund manager’s skill to read the direction of interest rates correctly. Fund managers ‘dynamically’ and continuously trade instruments of varying maturity based on the interest rate’s anticipated change. The right call can lead to profitable returns in these schemes, but investors can lose money if the call goes wrong.

2. Macroeconomic Factors

Certain factors like fiscal deficit, new government policies, and oil prices could affect the returns from the dynamic bond funds. One should stay invested for more extended periods to minimize the short-term risks.

3. Free from Normal Debt Fund Mandate

All debt funds should adhere to its investment mandate that dynamic bond funds need not follow. They can invest in long-term securities for even one month, all depending on the interest rate movement.

4. Tax-Efficiency

Dynamic bonds differ from other debt funds because of a potential shift in the interest cycle resulting in higher tax incidence. Investors need to stay invested for at least three years to qualify for a long term capital tax of 20% with indexation benefit. Else short-term capital gains would be added to the income and taxed as per the applicable income tax slab.

Things to Keep In Mind When Before Investing In Dynamic Bond Funds

1. Risk Factors

The dynamic bond funds are exposed to certain risks like every other instrument. However, when the rates go up or down very sharply, then dynamic bond funds might get hit badly.

2. 5-Year Track Record

Choose the fund with at least a 5-year track record with the proven ability to perform across multiple market scenarios.

3. Interest

The price of the bond and the changing interest rate are inversely proportional. So, if the interest rate increases, the cost of the bond will decrease and vice versa. The fund manager also holds some short-term and medium-term corporate bonds that additionally generate interest income.

To conclude, dynamic bond funds are slightly riskier, but they can deliver higher returns than the rest of the debt funds. If you find it challenging to choose the most suitable debt fund, you can talk to your financial consultant.

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