Can Dynamic Bond Funds Ride The Turbulent Market Tide?

As global economy struggles to recoup on the back of soaring inflation, uncertain geopolitical developments and rising interest rates, can dynamic bond funds rise to the occasion? Here are some pointers.

The Indian market has been trading range-bound since the beginning of 2022 and things are not looking great as we look at the half-yearly performance. With domestic equity markets taking a hit, mutual funds –considered a safe haven for many – are also struggling to reap gains for their investors. However, in such a precarious situation all is not lost for an investor as he or she has many investment avenues to bank on to create long-term wealth. One such option is dynamic bond funds

Understanding Dynamic Bond Funds

As the name implies, the composition and maturity profile of the dynamic bond schemes varies from other mutual fund schemes. The primary goal of dynamic bond funds is to deliver optimal returns in both rising and falling market circumstances. These majorly depend on the choices and portfolio management skills of the fund manager. These funds typically have massive portfolios worth several thousand crore in assets under management (AUM). There may occasionally be a significant gap between interest rate fluctuations and bond fund investors’ income may suffer as a result of this. 

For investors looking to ride the turbulent interest rate cycles, these funds are a great choice. Here, fund managers swap securities with varying maturities dynamically in response to expected rate changes. For instance, a fund manager might raise his or her holdings of long-term securities like gilts in the event of dropping interest rates. Dynamic bond funds’ inherent flexibility allows them to quickly transition between long, medium and short-term securities. For instance, the fund manager may extend the term if interest rates were set to decline. 

In contrast, the fund manager would curtail the tenure of the portfolio if he believed that interest rates had reached their lowest point and there was no more room for them to fall. In other words, the portfolio manager can lower the average maturity of the portfolio to reduce the risk of capital losses on long-term bonds. Although dynamic bond funds are frequently more volatile than short and medium-term

Characteristics of Dynamic Bond Funds

There are several unique characteristics of dynamic bond funds that must be kept in mind: No

Investment Tips for Dynamic Bond Funds Before selecting dynamic bond funds for investment, take into account the following factors.

• Past Performance: Before investing, it is crucial to research a fund’s past performance. While choosing dynamic bond funds to invest in, it is wise to evaluate the fund’s performance (annualised returns) for the last five years at the very least.

• Interest Rate Fluctuations: Examine the fund’s ability to effectively manage the downside risk during the period when interest rates are rising. It is vital to examine the fund’s performance over several market cycles.

• Duration Modification: Investors frequently take the modified duration into account when investing in debt funds. Investors invest in a fund if the adjusted duration of the fund fits with their investment horizon. Investors should make sure their time horizon aligns with the modified duration.

• Long-Term Investment Periods: Dynamic bond funds are best suited for investors with a three-year minimum investment horizon. Because short-term returns are erratic, long-term investments in dynamic bonds are advised.

Investing in Dynamic Bond Funds

For an investing horizon of three to five years, dynamic bond mutual funds are excellent. But not all investors would benefit from these funds. Investors looking for fixed returns with low risk should avoid these as interest rate changes affect the returns from dynamic bond funds. As a result, they present a somewhat significant danger. These funds are intended for investors who wish to participate in the bond market without making any interest rate decisions. Dynamic bond mutual funds are best avoided by conservative investors who do not wish to stake their investments on the judgment of fund management. 

Interest rate risk and credit risk are perils that dynamic bond funds are exposed to. Their ability to invest in securities of any maturity or credit quality is unrestricted. As a result, when the market behaves contrary to the fund manager’s expectations, their diverse portfolio may have an impact on the performance of the fund. As a result, investors who are aware of the risk associated with these funds can do so for a period of three to five years. By debt fund standards, dynamic bond funds are slightly riskier. In contrast to the others, they can, however, also produce higher returns. 

Conclusion
The ability to invest across investment durations is a benefit of dynamic bond funds. So, they qualify as both a long and short-duration funds. Additionally, they are unrestricted in their ability to invest in any range of credit quality. They also depend on the fund manager’s predictions for the market and interest rates. Due to this quality, dynamic bond funds have substantial credit risk, interest rate risk and fund manager risk associated with them. Before taking any investment decisions, it would be a wise call to contact your financial experts for better clarity.