Dynamic bond funds: Outsource duration investment bets to fund managers

Indian bond yields rose last week due to an increase in US yields. October saw foreign portfolio investors (FPIs) sell around $500 million in Indian debt, reversing the year-long trend of inflows. Hopes for a December rate cut have faded, with inflation expected to rise in the next print. These developments have delayed the gains for investors hoping to benefit from interest-rate cuts. 

“Global rate cuts are not translating into rate cuts locally. While yields did show signs of easing here, they now appear to be stuck, leaving duration investing in a state of uncertainty,” says Vidya Bala, co-founder, Primeinvestor.in. 

 

 

Most retail investors may fi­nd it challenging to predict the timing and quantum of rate cuts. Dynamic bond funds provide a good option for those looking for help in navigating interest-rate-related uncertainties. 

High on flexibility 

Dynamic bond funds allow fund managers to adjust portfolio duration based on anticipated rate cuts or hikes. “A dynamic bond fund acts like a gilt fund in a rate cut scenario and like a conservative short-term bond fund when rates rise,” says Devang Shah, head of fixed income, Axis Mutual Fund. They act as all-weather funds that investors can hold across rate cycles. 

Fund managers remain optimistic about rate cuts. “India’s high real positive rates offer the potential for rate cuts. The start of the rate cut in the US has also increased the probability of rate cuts in India soon,” says Puneet Pal, head of fixed income, PGIM India Mutual Fund. 

The demand-supply outlook is favourable, with JP Morgan’s inclusion of Indian bonds in its indices driving inflows.  

“We have witnessed a remarkable inflow of over Rs 1,35,000 crore in debt inflows year-to-date,” says Shah. 

Other supportive factors include low core inflation, fiscal consolidation reducing bond supply, and signs of slowing growth. 

Calls can go wrong 

Returns of dynamic bond funds depend on the fund manager’s ability to anticipate rate movements. “The fund manager’s bets might go wrong. When that happens, the returns of these funds take a hit,” says Abhishek Kumar, a Securities and Exchange Board of India (Sebi)-registered investment advisor and founder, SahajMoney.com. 

Some experts are sceptical about fund managers’ ability to anticipate rate movements. “The movement of duration in dynamic bond funds suggests fund managers are also struggling to accurately predict the direction of yields,” says Bala. 

She adds that some dynamic bond funds could take on higher credit risk to boost returns as there is no regulatory curb on them in this regard. 

Yields have already declined by about 50 basis points this year. Shah anticipates that the 10-year G-Sec yield may not dip significantly below 6.5 per cent in the near term. 

In an extreme scenario, yields could even rise. “If the expected interest rate cuts and declining yields don’t materialise, and yields rise instead, holding longer-duration assets may become sub-optimal,” says Joydeep Sen, corporate trainer and author. 

What should you do? 

According to Kumar, investors willing to take interest-rate risk and ready to hold these funds for 3-5 years can allocate 10–15 per cent of their debt portfolio to these funds. 

Some experts favour a different approach. “A barbell strategy of holding funds across duration (from short to long) would be better,” says Bala.  

She suggests a mix of short-duration, floating rate, corporate bond, and gilt funds. 

Investors considering short-term tactical positions over the next 6–9 months should approach this strategy with caution as such trading calls can go wrong.