Mutual Funds

Active management helps ride rate cycles

Radhika Merwin | Updated on May 19, 2019 Published on May 19, 2019

Dynamic bond funds are a good option for conservative investors who prefer stability

Over the past year, the yield on 10-year government securities have been yo-yoing wildly. For conservative investors who prefer stability and less volatility in returns, the volatility in bond prices can be unsettling. For such investors, dynamic bond funds that have the flexibility to juggle between short- and long-term debt instruments are a good option. Active management of duration by the fund managers helps these funds contain downsides better in iffy markets, while making the most of bond rallies. Given that funds in this category mostly invest a major portion of their assets in high-rated bonds and government securities, credit risk is usually relatively lower (though episodes such as the UTI Dynamic Bond Fund one — where the fund marked down certain investments, impacting its NAV performance — cannot be ruled out).

In the past one year, dynamic bond funds, as a category, have delivered about 6.7 per cent return, on par with corporate bond funds (investing 80 per cent or more in highest-rated debt instruments) and short-duration funds (Macaulay duration of 1-3 years). They have outperformed credit risk funds (minimum 65 per cent in below highest-rated instruments) and medium-duration funds (Macaulay duration of 3-4 years). Gilt funds (minimum of 80 per cent in G-Secs), banking and PSU Funds (minimum 80 per cent in debt instruments of banks and PSUs) and low-duration funds (Macaulay duration of 6-12 months), though, have outperformed dynamic bond funds by 60-120 bps over the past one year.

Over a longer run — five- and 10-year periods — dynamic bond funds have delivered healthy returns of 7.5-8 per cent, trumping most other debt fund categories. While the high-teen double returns of gilt funds during the bumper years of 2014 and 2016 have helped them deliver superior returns, the outperformance vis-à-vis dynamic bond funds is not too wide over the long run.

Active strategy

Interest rate movements in the economy impact bond prices. As long-duration bonds are more sensitive to interest rates, the fund manager increases the duration to cash in on the rally in bonds in a falling rate scenario. In a rising rate environment, the fund manager reduces the duration of the fund to cap losses.

Such active management of duration helps dynamic bond funds ride rate movements efficiently. Hence, in the lacklustre and volatile years of 2013, 2015 and 2017 for bonds, dynamic bond funds managed to deliver better returns than long-duration gilt funds. For instance, in 2017, the average maturity of dynamic bond funds ranged widely between 2-4 years and 11-13 years, helping them tide over volatility.

Until September-October last year, rate hikes by the RBI, inflation worries and tightening global liquidity had led to rise in interest rates. The G-Sec yield had peaked at 8.1 per cent in September. While the RBI bringing in measures to ease liquidity led the yield on 10-year G-Secs to fall sharply to 7.2 per cent levels by December-end, since February this year, bond yields have been hardening, trading at 7.3-7.4 per cent.

Most dynamic bond funds upped their maturity to 6-8 years by March 2019. But given that bond markets have turned jittery over the past month, funds may lower their maturity in the coming months.

Top performers

Edelweiss Dynamic Bond Fund, Kotak Dynamic Bond Fund, Franklin India Dynamic Accrual Fund, IDFC Dynamic Bond Fund, Axis Dynamic Bond Fund and SBI Dynamic Bond Fund have been some of the top-performing schemes in this category over the past year, delivering 7.5-9.5 per cent returns. UTI Dynamic Bond, a good fund over the long run, has taken it on the chin in recent months, after marking down investments in the non-convertible debentures (NCDs) of Jorabat Shillong Expressway (JSEL), an IL&FS special purpose vehicle. The fund has delivered less than one per cent return over the past one year; it has delivered negative 3 per cent returns year-to-date in 2019.

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