Dynamic bond funds are a class of debt schemes that alter allocations between short- and long-term bonds. The strategy is aimed at taking advantage of fluctuating interest rates. But if the duration call goes wrong, investors may suffer.
Looking at the current interest rate movements, there is a possibility of the inflation moving up, followed by interest rates, according to George Heber Joseph, chief investment officer and chief investment officer at ITI Mutual Fund. He sees a high probability of rates moving significantly higher in three to five years. And as lay investors don’t have the capability to time the interest-rate movement, he said dynamic bond funds would be the best debt option.
He, however, caveats that some bond funds are buying suspect, inferior quality credit paper. That’s where a lot of chaos happened in the industry, he said. There’s also reasonable quality paper that’s very illiquid, he said. A fund house needs to have high-quality bonds in the basket so when an opportunity comes to make gains or a need arises to for liquidity, the fund is easily able to manage it, Joseph said.
Raghvendra Nath, managing director at Ladderup Wealth, disagrees. A dynamic bond fund is meant for sophisticated investors and not for those who don’t understand price risks. An investor’s expectation from a fixed income mutual fund product is that it will beat inflation by 1-2% or at least will keep pace with inflation, he said. But when looking at dynamic bond funds’ 10-year track record, said Nath, a lot of schemes would have delivered 2-3% in bad years and 14-15% in good ones, he said.
What that means is that volatility is far higher for an average investor, according to Nath. Currently, the market is at the bottom of the interest-rate cycle, Nath said, and he does not suggest such schemes when the interest rates are only expected to go up. Returns from a dynamic bond fund will be lower than a corporate bond fund with a same duration, but a higher yield to maturity, he said.
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