Want to invest in dynamic bond funds? Here's a guide
Want to invest in dynamic bond funds? Here's a guide
21 Feb 2025
Indian savers are turning to dynamic bond funds as they seek the best of both worlds: safety and returns.
These funds actively manage their portfolio, adjusting their holdings based on changing interest rates. This strategy aims to offer stability during volatile periods and attractive returns during stable times.
Knowing how these funds work can help you navigate the world of investing with confidence.
What are dynamic bond funds?
Basics
Dynamic bond funds are debt mutual funds that actively manage their portfolios by making strategic adjustments based on interest rate forecasts.
Unlike fixed maturity or short-term debt funds, they have the flexibility to shift between long and short-duration bonds.
If falling interest rates are anticipated, they opt for longer-duration bonds to benefit from capital gains. On the other hand, if rates are rising, they choose short-term bonds to limit risk.
The interest rate connection
Interest rates
Dynamic bond funds in India actively respond to interest rate fluctuations, providing a tactical approach for unpredictable economic environments.
During declining rate cycles, these funds raise their allocation to longer-duration bonds, benefiting from the rising bond prices (which are inversely related to the rates).
This strategy not only targets capital appreciation but also a steady stream of interest income, adeptly steering through market changes.
Risks involved
Risk factors
Investing in dynamic bond funds is not without risks.
The main risk is interest rate risk; if the fund manager makes a wrong call about where interest rates are headed, it can hurt your returns.
Credit risk is also a factor, as these funds can invest in corporate bonds with different credit ratings.
That said, fund managers aim to manage these risks through diversification and active management.
Taxation aspect
Taxes
Indian investors need to understand the taxation on returns from dynamic bond funds.
If units are sold within three years of the purchase date, short-term capital gains tax applies at the individual's income tax slab rates.
Sales after three years incur long-term capital gains tax at 20% with indexation benefits.
Indexation benefits adjust the taxable gain for inflation, which can reduce the tax liability.
Making an informed choice
Decision making
Before you invest in dynamic bond funds, assess your investment horizon and risk tolerance.
These are crucial in ensuring that you choose an investment that fits your financial objectives and comfort level with market volatility.
Also, analyzing past performance across different interest rate cycles can give you a clearer picture of how effectively a fund adjusts its strategy to changing economic environments.