Should You Invest In Dynamic Bond Funds?
Equity Funds Vs Debt Funds: Differences & Things To Consider Before Making Investment Decisions
14 December 2021
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14 December 2021A 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.
Here, we will cover all important details regarding dynamic bond funds, including their benefits and taxation. If you wish to know more about these schemes, read on!
Table of contents
How Does a Dynamic Bond Fund Work?
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.
Also Read – https://navi.com/blog/all-about-direct-plans/
Who Should Invest in Dynamic Bond Funds?
A dynamic bond fund is a suitable option for the following individuals:
- Individuals with a moderate risk appetite
- Investors who are looking for higher returns than fixed deposits without equity exposure
- Investors who are looking for optimal returns in both falling and rising interest rate regimes
- Individuals who are seeking exposure to fixed income securities
- Investors are willing to take part in rallies in the bond market but do not want to take calls on interest rates.
If you are a risk-averse individual, you may consider other types of debt funds, for example, the Navi Liquid Fund or the Navi Ultra Short Term Fund.
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What Are the Benefits of Investing in Dynamic Bond Funds?
Here are some reasons why investors may consider investing in a dynamic bond fund:
No investment mandate
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.
Access to professional expertise
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.
High liquidity
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.
Taxation of Dynamic Bond Funds
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 as 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.
Things to Consider Before Investing in Dynamic Bond Funds
Here are certain aspects that you must keep in mind before allocating your savings to a dynamic bond fund:
Investment objective
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.
Risk appetite
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.
Expense ratio
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.
Experience of the fund manager
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.
Fund’s past performance
Past returns of a fund are 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.
Direct/regular plan
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.
Mode of investment
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 with them in one go.
Alternatively, one can opt for an SIP, which enables an individual to invest a fixed sum at regular intervals, for example, yearly/quarterly/monthly.
Also Read – https://navi.com/blog/best-mutual-funds/
Final Word
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.
Frequently Asked Questions
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.
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Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
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