September 06 , 2013
Dynamic bond funds are the class of debt funds that ride on interest rates cycles by choosing securities having durations that can maximize returns. Read on to know how dynamic funds work, if they are suitable for you and how to choose a dynamic fund.
What is a dynamic bond fund
In debt funds duration of underlying securities plays a key role in determining nature and performance. The portfolio of dynamic debt funds is dynamic with debt securities of various durations. Regular debt funds have securities of a pre-decided duration range. They could be long term gilt funds having government bonds of duration 10 years or more, medium term funds with duration 3-5 years, short term funds of average duration of 1-2 years and liquid funds of average duration of 2-3 months.
However in dynamic bond funds the fund manager can tweak his portfolio using discretion to select securities with durations best suited to capture market interest rate scenario of the moment.
Little understanding of how duration affects returns in debt funds will help. We know that in bonds interest rate and price are inversely related. (Read article to know why-link) Price-rate effect is more pronounced as duration increases. Therefore in a scenario of market interest rate rise where bond prices are falling the fund manager moves to securities with less duration. Conversely when rates are rising he would move to bonds with long duration.
Thus performance of dynamic bond funds largely depends on whether the fund manager's anticipation of interest rate cycle turns out of true or not.
Is a dynamic bond fund suitable for me
Dynamic bond funds are suitable for retail investors who wish to invest in debt securities for medium to long term.
How do I choose my dynamic bond fund
Since much depends on interest rate cycle calls the fund manager's track record and style play a big role in selecting dynamic bond funds. Secondly fund size affects the ability to move in and out of securities. Too big or too small a size should be avoided.
Taxation in dynamic bond funds
Dynamic bond funds are treated like other debt funds for taxation purpose. Capital gains tax and dividend distribution tax are applicable.