Widely read:
Dynamic bond funds have the flexibility to dynamically manage their average maturities by switching to longer or shorter maturity bonds based on their interest-rate outlook. While, on paper, this category has the flexibility to move around the maturity curve, data suggests that most of these funds usually remain on the medium to the long side of the duration curve. Thus, these funds do get impacted when interest rates rise. That is also contributing to the drop in their NAVs as the yields have risen and are expected to only rise from here on.
In our opinion, it is quite hard to predict interest rates all the time accurately. Further, one should make investments depending on the purpose of investing, but here it is more dependent on external factors. So, these funds are way too active for our comfort. On the fixed-income side, we err on the side of caution. We prefer funds which take interest-rate calls in a relatively narrower range, depend more on accrual income rather than trying to derive gains by actively rotating around bonds of different maturity and usually maintain high-quality portfolios. Fixed-income investors generally expect steady returns with limited volatility. And on the majority of occasions, short-duration funds with a predictable maturity structure outscore dynamic bond funds on this metric. A comparison of five-year rolling returns since 2010 (see the graph 'Five-year average rolling returns') of dynamic bond funds vis-à-vis short-duration funds highlights the same.
If you opt for dynamic bond funds, remember that while they can be rewarding, they will be volatile depending on how skilfully a fund manager can manoeuvre them through an interest-rate cycle. But as mentioned above, these funds have some frills attached, which you will have to accept. Otherwise, if you want relatively steadier returns with less volatility, opt for short-duration funds with a more predictable maturity structure.
Suggested read: Are dynamic bond funds a good option for investors over a five-year horizon?
This article was originally published on April 22, 2022.
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