Secure your debt allocation with an all-weather dynamic bond fund

OVER the past few years, the craze of investing in equity mutual among common investors has grown rapidly, with monthly SIP books consistently breaking records and approaching $2 billion. However, Indian savers’ affinity for owning debt mutual funds continues to be lacklustre, despite its ability to provide stable returns in a volatile market. Additionally, it offers a relatively better risk-return profile when compared to other traditional options. It must be noted that several categories of debt mutual funds have underlying assets that are backed by government securities.

Investor refrain

So, why do common savers have a relatively lower affinity for debt mutual funds? To begin with, the relationship between the bond price and interest rate is inversely proportional. In simpler terms, one can make money even in a falling interest rate market. However, this exercise is not as simple as it sounds theoretically. Even for seasonal debt market experts, predicting the trajectory of interest rates is quite difficult. Benchmark interest rates that the central bank typically sets are dependent on several macroeconomic variables ranging from inflation, unemployment, currency movement to interest rate stance of global central banks. Therefore, it becomes a tortuous task for a common investor to form an opinion on the direction of interest rates to take a calculative risk.

In such a situation, investing via a debt mutual fund, especially the dynamic bond fund, emerges as a viable option for investors who want stable returns without worrying about the direction of interest rates. This category fund holds the potential to generate a reasonable return regardless of market conditions, thanks to its strategy of investing across maturities and credits. The biggest advantage is that the fund manager can invest across a wide spectrum of durations, from 1-10 years, making it the most palatable instrument for a saver who isn’t bothered about the interest rate direction.

There are several schemes available in this category. Of these, ICICI Prudential All Seasons Bond Fund is one of the top names in this category. It is the biggest scheme in terms of assets and has a consistent track-record of over 10 years. Since its inception in May 2009, the fund has managed duration in various interest rate scenarios and delivered NAV growth in all these conditions. An in-house model forms the basis of the investment decision for the fund. Owing to timely manoeuvring, investors who have remained invested in the fund has benefited from the fund across varying timeframes. Over 3, 5 and 10 years, the fund is among the top performer in its category delivering 7.1%, 7.2% and 9.3% respectively (data as on November 30, 2022).

Workings of a dynamic bond fund

A debt fund manager has the liberty to invest in securities with different time horizons. Dynamic fund managers keep shuffling funds’ average maturity periods, depending upon their view on interest rates.

When the central bank turns hawkish, the dynamic bond fund manager increases allocation to bonds with a shorter maturity period. This helps them mitigate market loss. On the other hand, when central bank commentary turns dovish, fund managers will increase allocation to higher maturity bonds to profit from capital appreciation. So, in the current macroeconomic environment, if one considers buying dynamic bonds, they should look for funds with a Macaulay duration of less than three years. A shorter Macaulay duration reduces bond price volatility. It must be noted that the RBI has hiked benchmark interest rates by 225 basis points in the last one and half years.

The fund manager’s assessment of the interest rate direction determines the share of allocation to government securities and corporate bonds. So, when interest rates are low, the dynamic bond fund typically behaves like an accrual scheme with a focus on earning interest income primarily from the coupon that is held until maturity. On the other hand, when interest rates are high, the scheme will behave like a long duration scheme.

While choosing a fund in this category, there are several options available. But it is crucial to check the fund manager’s experience navigating previous interest-rate cycles. Investors should approach this category with a time horizon of three years and above in mind.

Managing Partner, I Scale Financial Concepts