A debt fund for all seasons

Based on the investor’s profile, mutual fund portfolios feature a mix of equity and debt funds, in varying proportions. For instance, if you are someone who has a high risk appetite, a large part of your portfolio would be dedicated to high risk-high return equity mutual funds. Across portfolios, prudent investors choose to allocate a portion to debt funds as these schemes are known to be relatively safer than equity funds. In addition to diversification, such funds are likely to offer stable returns, especially during volatile markets, making them an excellent part of the portfolio. Even within debt funds there are multiple options available for a debt investor. One of the categories to invest is dynamic bond fund which provides flexibility to a fund manager to move across maturities and credit.

Reasons to invest in dynamic bond funds

Dynamic bond funds can be defined as debt funds which park their corpus in fixed income and money market instruments such as sovereign bonds and corporate bonds. As mentioned earlier, dynamic bonds invest in securities across different maturities, thus offering investors benefits such as reasonable returns, tax-efficiency, flexible investment horizons and better liquidity. They also allow investors to ensure optimal diversification across corporate bonds and government securities, facilitating robust returns without compromising on security. The biggest advantage of dynamic bond funds is the modified duration which is maintained in a range of 1-10 years, making it a hugely versatile investment.

Dynamic bond funds for volatile markets

Typically, dynamic bond funds aim to benefit from interest rate volatility and increase their duration when interest rate is expected to fall, thus benefiting from capital appreciation. Further, the scheme has the option of reducing their duration when the interest rate is expected to rise, with the aim of mitigating risks from marked-to-market losses. Such factors make dynamic bond fund particularly suitable for the current market conditions, wherein the yield curve is moderately steep.

Additionally, changes in macro-economic factors can prompt dynamic bond funds to lower or increase their duration as required. For example in a worsening macro environment like high inflation, current account and fiscal deficit would potentially lead to rise in interest rates, as seen by the consistent repo rate hikes by the Reserve Bank of India in recent times. This has prompted dynamic bond funds to pivot towards a lower duration to ensure optimal returns even during volatile situations. Further, the fund can increase exposure to credit as and when spreads are available at reasonable risk.

ICICI Prudential All Seasons Bond Fund

With a modified duration of 2.35 years, based on the macro-economic factors, and a yield to maturity of 7.16%, the ICICI Prudential All Seasons Bond Fund is an excellent option for investors keen on building positions in dynamic bond funds and meeting the market volatility head-on. The fund invests in high and medium quality debt instruments ranging from low to long maturity.

Given the current market scenario, the scheme’s Macaulay duration has been maintained at 2.47 years, with sizeable exposure towards spread assets for better accrual income. Also, the fund offers a good mix of instruments which benefits from higher term premium and better liquidity. Based on the interest rate scenario, the scheme takes tactical calls on investments in corporate bonds and gilts. Accordingly, when the interest rates are high, the scheme will behave like a long duration scheme and when rates are low, it will act as an accrual scheme, offering robust returns across market conditions and helping investors benefit from the move, irrespective of whether yields fall or rise.

Considering the current market condition, the scheme has maintained its exposure to higher maturity government securities to benefit from term premium, while enjoying good exposure to spread assets for better accruals. Going forward it is very likely that the scheme would endeavour to ensure exposure to spread assets with a rating above AA-. With a moderate risk rating, and the ability to help you diversify and earn stable returns across volatile markets, the fund is an optimal offering for a debt investor with a long term investment horizon. To summarise, dynamic bond fund is an evergreen product since they provide reasonable returns in all market conditions.

The author is from Affluenz Wealth Advisors.