A dynamic bond fund is an open-ended debt mutual fund that invests in debt instruments with different maturity periods. Fund managers of such schemes dynamically alter the Macaulay duration (weighted average maturity period) of a portfolio to generate maximum returns in both rising and falling interest rate regimes.
This article provides all the details about dynamic bond funds – how they work, features, benefits, taxation, best dynamic bond funds to invest and more. Keep reading!
The nature of these mutual fund schemes allows fund managers to alter the proportion of investment in short-term, medium-term, and long-term debt instruments.
For instance, let’s say that interest rates in the economy are about to decrease. Fund managers of this scheme can increase the allocation to debt instruments having a longer maturity period.
On the flip side, in a rising interest rate environment, fund managers can increase their allocation to debt securities having a shorter maturity period. A portfolio manager can mitigate financial risk and generate optimal returns by altering the portfolio’s Macaulay duration.
Note that if the interest rate movements do not align with the fund manager’s expectations, the fund’s performance is impacted. Accordingly, these schemes are riskier than most other types of debt funds.
The fund managers of dynamic bond funds use the interest rate projections of the economy to maximise their returns. Such funds primarily invest in:
Here are some reasons why investors may consider investing in a dynamic bond fund:
Contrary to other debt funds, dynamic bond funds do not need to adhere to SEBI’s investment-related guidelines. As noted above, these schemes can allocate the fund corpus to debt securities with different maturity periods. This allows fund managers to take advantage of the interest rate movements and generate higher returns for investors.
Fund managers of dynamic bond funds are experts in their field. They utilise their specialised skills to generate optimal returns in the changing economic environment.
Dynamic bond funds are highly liquid investment options as investors can redeem their units within 2 working days after placing a redemption request with the asset management company (AMC). Furthermore, fund houses do not charge any exit load upon redemption.
The gains from a dynamic fund are inversely proportional to the interest rates. Economic factors such as oil prices, fiscal deficit, inflation and government policies influence the interest rates, which can impact the asset allocation decisions made by the fund manager.
Dynamic bond funds bear low to moderate risk. These funds offer higher returns than other short-term funds because the fund manager makes optimum use of the duration strategy. By altering the portfolio as per the interest rates in the markets, the fund manager ensures maximum returns against low-risk assets.
Individuals who stay invested for 3-5 years can take advantage of the low tax rates associated with debt mutual funds. Dynamic bond funds are taxed just like any other debt funds. In the case of short-term capital gains, taxation takes place as per the applicable tax slab. For long-term capital gains, there is a flat 20% tax with indexation benefits.
The tax implications concerning dynamic bond funds are similar to any other type of debt mutual fund. If investors opt out of the scheme within 3 years from the date of purchase, the returns are termed Short-Term Capital Gains (STCG). These gains are taxed according to the income tax bracket of the investor.
Nevertheless, if an individual redeems the units after three years from the investment date, the realised returns (Long-Term Capital Gains) attract a 20% taxation rate. Note that eligible investors will get indexation benefits on their capital gains.
Investing in dynamic bond funds is most suitable for investors who have a moderate risk appetite. Bond funds are considered safer than equity-based mutual funds. The returns from dynamic bond funds depend mostly on the interest rate movement of the country.
If you are an investor who is willing to gain stable returns from the debt asset classes, then dynamic bond funds might be the one for you.
Here’s a list of a few best-performing dynamic bond funds in 2022:
|Name of the Mutual Fund||5-year Annualised Returns*|
|Kotak Dynamic Bond Fund – Direct Plan-Growth||7.53%|
|ICICI Prudential All Seasons Bond Fund – Direct Plan-Growth||7.16%|
|PGIM India Dynamic Bond Fund – Direct Plan-Growth||6.73%|
|Axis Dynamic Bond Fund – Direct Plan-Growth||6.71%|
|Franklin India Dynamic Accrual Fund – Direct-Growth||6.62%|
**Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
Here are certain aspects that you must keep in mind before allocating your savings to a dynamic bond fund:
The investment objective of all individuals is not identical. Before you invest your savings in a dynamic bond fund, you should ensure that your financial goals are in line with the scheme’s objective.
Similar to financial goals, the risk-bearing capacity is not the same for all investors. If you have a high risk-appetite and wish to earn the highest possible returns, you may not want to consider investing in dynamic bond funds.
The expense ratio is the yearly fee that an asset management company imposes on investors to cover the cost of running a fund. This annual charge impacts the returns that you earn on your mutual fund investments. Hence, you must make sure to compare the expense ratio of different dynamic bond funds along with other aspects before investing.
Fund managers of dynamic bond funds carry out thorough research and analysis before taking all buy-and-sell decisions. Accordingly, the performance of these funds depends upon the expertise of the fund manager.
This is why it is imperative that you take into account the fund manager’s experience and track record before choosing to invest in a particular scheme.
The past return of a fund is an essential factor that you must consider before investing. A scheme’s historical performance indicates whether the fund managers have achieved their predetermined goals. Nevertheless, you must note that the past returns of a fund do not give an estimate regarding the scheme’s future performance.
By considering this aspect, you can find out how well a dynamic bond fund was able to cope with the downside risk when interest rates were on the rise. In that regard, checking the returns generated by a fund during various market cycles is imperative.
A direct plan is offered by a fund house directly to investors. In other words, investing in mutual funds via this route doesn’t involve an intermediary.
On the other hand, allocating funds through a regular plan involves a third-party agent (broker or distributor). In this case, an asset management company has to pay a commission to the intermediary. Accordingly, a regular plan has a higher expense ratio than a direct plan, which results in a lower NAV. Before investing in dynamic bond funds, you decide whether to opt for a direct or regular plan.
To invest in dynamic bond funds or any other mutual fund scheme, you can choose either the lump sum mode or a systematic investment plan (SIP). The lump-sum route allows investors to allocate the entire amount available to them in one go.
Alternatively, one can opt for a SIP, which enables an individual to invest a fixed sum at regular intervals, for example, yearly/quarterly/monthly.
Dynamic bond funds are certainly an option worth considering if you’re looking to earn high returns by investing in debt funds. That said, you must make sure to check if the objective of the scheme is in line with your financial goals and investment time horizon. If you want to start investing, visit Navi Mutual Fund to get started now!
*Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
Ans: No, dynamic bond funds do not come with any lock-in period. You can redeem your units whenever you want. Simply place a request with the fund house by following the necessary procedure to opt out of the scheme.
Ans: Yield to maturity (YTM) refers to the overall returns expected on debt/fixed income securities if they are held until maturity. To put it in another way, yield to maturity refers to the internal rate of return of a debt instrument held by the investor till maturity.
This is based on the assumption that coupon payments are made according to the schedule.
Ans: Bond prices and interest rates have an inverse relationship. When interest rates in the economy increase, the price of the debt fund’s underlying securities falls. Accordingly, the Net asset value (NAV) of the scheme decreases. But when interest rates plunge, the price of the underlying securities rises, leading to an increase in the fund’s NAV.
Ans: No. Individuals are not eligible for tax deductions under Section 80C of the Income Tax Act, 1961 for the returns earned on investments in dynamic bond funds. That said, they are eligible for indexation benefits in case of long-term capital gains.
Ans: Corporate bond funds invest over 80% of the fund corpus in corporate bonds. Whereas dynamic bond funds strategically allocate the investment corpus to short and long-term bonds, aiming to earn the highest possible returns by making most of the changing interest rates.
Ans: Dynamic bond funds are subject to the credit risk on debt assets. Credit risk is the possibility of a loss on a debt due to the borrower’s failure to repay.
Dynamic bonds that primarily invest in government/PSU bonds and securities have no credit risk. There is a guarantee that the credit will be repaid after the maturity of the securities.
On the other hand, dynamic bond funds with most allocations in corporate bonds and money market instruments have a higher credit risk.
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Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
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