Dynamic Bond Fund - Label Justified
MF shots (Part 10)- is an exclusive series of article which will try to explain in each category of mutual fund. This article focuses on Dynamic Bond funds which invest for varying maturities.
Estimated time to read - 6 minutes
Overview -
MF shots - name describes itself where Mutual Fund categories are explained in a brief manner to avoid clutter of information. The current article is continuation of MF shots series by Cellestial Wealth. Previously I have written about short term & medium term debt mutual funds of which can be found by clicking on each category. Each article takes less than 6 minutes but states a few key pointers to be looked upon when choosing a category.
Overnight fund – invests in securities with maturity of 1 day.
Liquid fund – invests in securities with maturity of 91 days.
Ultra short duration funds – invests in securities with maturity of 3-6 months
Low duration funds - invests in securities with maturity of 6 months to 1 year.
Money market funds - invest in securities with maturity upto 1 year.
Short duration funds - invest in securities with maturity ranging from 1 to 3 years.
Medium duration funds - invest in securities with maturity ranging from 3-4 years.
Medium to Long Duration funds - invest in securities with maturity ranging from 4-7 years.
Long duration funds - invest in security with maturity of more than 7 years.
Brief –
The categories in the others segment doesn’t have a defined maturity & hence might vary from one scheme to another depending upon securities chosen by the fund manager.
In the dynamic bond category which we will be understanding in this article, the fund manager has the discretion to chose from various maturities available. The category returns might be difficult to forecast due to varying maturity & credit quality of portfolio.
Investment objective –
The investment objective is to benefit from expected interest rate movements. If
1. If manager expects interest rates to increase -
The fund manager will invest in short term securities (1 year or 1 month) to reduce losses in case of interest rate hikes.
2. If fund manager expects decline in interest rates -
Fund manager will invest in longer term securities (5 year & 10 year) to maximize the benefit from decline in interest rates
Suitable for which type of goals –
A normal investor who doesn’t track debt markets regularly or lack view on interest rates can use this category. But one must ensure the duration of goal & portfolio of the scheme matches the requirements otherwise one might end up in trouble if there is horizon mismatch.
What parameters to check –
1. Fund manager experience –
Here there are no restrictions on maturity. Hence the manager has a discretion over which duration to invest in whether for short, medium or long duration. Due to these factors the fund manager expertise is key for future returns because if the fund manager holds long duration securities when interest rates are expected to rise the situation can be tricky.
2. Average maturity of fund – The average maturity of fund should match the goal duration. This factor should be monitored periodically as portfolio might change over a period of time.
3. Investment in corporate versus government security – Some managers try to enhance the yield of the funds by investing in lower rated securities where the chances of default are high. Although it increases returns but when the cycle turns there are capital losses to the investor.
What to avoid –
1. Too high exposure to lower credit rated security – if a fund manager continuously over period of time has high exposure to lower credit rated securities then its best to avoid & invest in other fund.
2. Expense ratio –
The returns are moderate (5-8%) & expense ratio should also be moderate in order to allow investor earn returns. Union Dynamic fund has the highest expense ratio of 1.23% which will reduce investor returns. The impact would be seen when the returns of the fund remain low.
3. Lure of high past returns –
Past returns are no predictor of future returns. If one finds high past returns one should try to identify what might have contributed to outperformance.
Interesting insights –
1. JM Dynamic Bond fund & SBI Dynamic Bond Fund has maturity of 1 year & 0.88 year respectively, reflecting the fund managers are expecting a interest rate hike.
2. The fund manager also have invested part of their funds in high risk securities (i.e. lower credit rated companies) to enhance their yield.
3. The average Yield to Maturity of category ranges between 5-6%.
4. The average portfolio maturity of category ranges between 3-5 years.
5. The Union Dynamic Fund has maturity of 5 years & Nippon Dynamic Fund maturity at 6.24 years.
6. The investment of fund in the category is 50% government security & 50% in corporate security.
7. 90% of funds (AUM) invested within top 10 schemes in category.
Conclusion -
The category allows the fund manager all the freedom to invest in corporate & government securities with any maturity. So the fund manager’s role becomes more critical in order to assess the fund. The category objective seems to be fair but should be only invested by investors who know about the category & stay updated periodically as in debt markets the buy & hold approach would result a portfolio completely different from investor’s objectives.
The returns & risk vary of each scheme & hence it isn’t easy to compare schemes by just looking at past returns & current portfolio. One should view past returns along with holdings at that point in time to assess performance correctly. Currently, I expect interest rates to rise (I might be wrong & happy to be) & hence would prefer schemes having lower portfolio maturity (below 1 year) if I am looking to invest in the category.
Notes -
Link to full excel sheet containing data can be accesses here.
Top 10 funds by lowest expense ratio -
Top 10 funds by highest AUM -