Best Dynamic Bond Funds to Invest in 2021


Did you know that bond prices and interest rates are inter-linked? Various macro-economic factors such as government borrowing, central bank's objective, and inflation impact the movement of interest rates, thereby affecting the bond prices. When the yields move up, prices of bonds go down and therefore, debt mutual funds,especially those holding longer maturity instruments, witness diminishing returns.

If you wish to earn optimal returns during the rising and falling interest rate scenario, you can consider investing in Dynamic Bond Funds. Unlike other debt mutual fund categories that follow a pre-determined portfolio duration and hold the instruments till maturity, Dynamic Bond Funds have the flexibility to shift investments between short term and long term bonds based on interest rate scenario.

Creating a debt portfolio that works well regardless of the interest rate cycle can be a challenging task if you do not understand interest rate movement. By investing in dynamic bond funds you can use the fluctuation in interest rate movement to your advantage and also earn attractive returns.

Image by Nattanan Kanchanaprat from Pixabay

What are Dynamic Bond Funds?

According to SEBI categorisation norms, dynamic bond funds are open-ended dynamic debt schemes that invest across duration. These funds have the flexibility to invest in short-term instruments, such as commercial paper (CP) and certificates of deposit (CD), or medium to long-term instruments, such as corporate bonds and gilt securities.

When the interest rates are falling, long-term instruments tend to perform well; while in the rising interest rate scenario, short-term instruments tend to perform better. So if a dynamic bond fund anticipates an escalating interest rate scenario, it will increase holdings to short-term instruments and vice versa. Thus, it can take advantage of the changing rates and invest accordingly to create an all-season and tax-efficient portfolio.

Graph: Placement of Dynamic Bond Funds on the Risk-Return spectrum

For illustration purpose only

The performance of the fund depends on the fund manager's perception of the interest rate movement. If the manager fails to accurately gauge the movement of interest rates, or is unable to time the investment precisely, investors may suffer losses. Moreover, in case of unanticipated movement in interest rate the fund may witness high volatility in the short term.

Therefore, invest in Dynamic Bond Fund only if you can handle volatility and if your investment horizon isat least 3-5 years.

Table: Performance scorecard of Dynamic Bond Funds

Scheme Name Absolute (%) CAGR (%)
1 Year 2 Years 3 Years 5 Years
IDFC Dynamic Bond Fund 5.75 11.57 10.64 9.46
Axis Dynamic Bond Fund 7.72 11.34 10.28 9.26
Kotak Dynamic Bond Fund 7.82 10.41 10.07 9.51
SBI Dynamic Bond Fund 5.08 11.10 10.04 9.47
DSP Strategic Bond Fund 5.11 10.63 9.97 8.43
ICICI Pru All Seasons Bond Fund 8.58 11.08 9.92 9.89
Mirae Asset Dynamic Bond Fund 4.41 10.68 9.81 --
PGIM India Dynamic Bond Fund 5.90 9.65 9.40 9.28
L&T Flexi Bond Fund 4.82 9.18 8.80 8.51
Quantum Dynamic Bond Fund 4.78 9.60 8.62 8.51
Crisil Composite Bond Fund Index 6.75 10.65 9.60 8.53
Data as on April 23, 2021
(Source: ACE MF)
*Please note, this table only represents the best performing Dynamic Bond Fund based solely on past returns and is NOT a recommendation. Mutual Fund investments are subject to market risks. Read all scheme related documents carefully. Past performance is not an indicator for future returns. The percentage returns shown are only for an indicative purpose. Speak to your investment advisor for further assistance before investing.

Though Dynamic bond funds can be risky, it has the potential to generate higher returns when compared to short to medium duration debt mutual funds. Since the category has the flexibility to align holdings with the market conditions, they can benefit from the accrual as well as duration strategy.

While the impact of interest rate fluctuation may fade out over a period, one should be wary of funds that can attract higher credit risk. In the last few years, many funds in the category have increased their weightage to securities issued by government and quasi-government units as the debt fund category grappled with rising instances of defaults and downgrades.

However, some funds still have higher allocation to securities issued by private players than can generate higher returns, but also expose the portfolio to credit risk. Therefore, choose Dynamic Bond Funds wisely.

Best Dynamic Bond Funds to invest in 2021:

Some of the best Dynamic Bond Funds that have been able to constantly reward investors with superior risk-adjusted returns based on our analysis and research at PersonalFN are:

- IDFC Dynamic Bond Fund

- Mirae Asset Dynamic Bond Fund

- SBI Dynamic Bond Fund

- Quantum Dynamic Bond Fund

- BNP Paribas Flexi Debt Fund

Here are the parameters to look into while selecting the best Dynamic Bond Fund

Quantitative parameters

Check whether the fund has a decent track record of delivering adequate and stable returns across time horizons when compared to the category average and the benchmark index. The fund should be able to take active and timely calls to benefit across interest rate cycles.

Furthermore, the fund should be able to justify the returns by generating competitive risk-adjusted returns for its investors. To determine whether the fund has rewarded its investors well for the risk they have taken, assess risk-reward ratios like Sharpe Ratio, Sortino Ratio, and Standard Deviation over a 3-year period.

So when you are shortlisting funds for your portfolio, give preference to those funds that stand strong on risk-reward parameters.

Qualitative parameters

The fund should be well-placed to determine the general maturity range for the portfolio after considering the interest rate outlook based on the economic environment (inflation, government's borrowing plan, fiscal deficit, etc.), the performance of the corporate sector, general liquidity situation, and so on.

Ensure that fund resists from taking high credit risk by limiting exposure to moderate and low-rated securities and makes optimal use of portfolio diversification to mitigate risk. If your preference is safety over returns, you should consider funds primarily focusing on Government and Quasi-government securities. Avoid funds that have higher allocation to papers issued by private units.

The fund's portfolio should be well-diversified across securities issued by various companies and group of companies. Remember that a concentrated portfolio can expose you, the investor, to higher risk. Additionally, keep a tab on the expense ratio of the fund. Additionally, since the performance of a Dynamic Bond Fund depends on the fund manager's ability to accurately and timely gauge the interest rate movement check the qualification, experience, and track record of schemes they manage.

Most importantly, always give higher importance to fund houses that follow robust investment processes and systems along with sound risk management techniques in place.

Watch this short video on the lessons an investor can remember while investing in Debt Mutual Funds.

Outlook for Dynamic Bond Funds in 2021

With interest rates at multi-year low, funds with flexible investment mandate can be well positioned to change the duration strategy and shift to shorter maturity instruments that may reduce interest rate risk once interest rates change direction and start moving upwards.

Do note that the lockdown-like restrictions imposed in many parts of the country due to the massive resurgence of COVID-19 has raised questions about the ability of businesses to run normally. This may increase the chances of defaults and bad loans by private entities. During such a scenario, it is important to focus on safety over returns. Choose a dynamic bond fund that has predominant allocation to securities issued by government and public sector units because they are highly liquid and enjoy high credit rating.

Invest in a worthy scheme that can take timely duration calls to reduce the impact of interest rate fluctuations and at the same time hold high quality portfolio to reward investors with better risk-adjusted returns.

Dynamic bond fund can be highly volatile in the near term when the interest rates change direction. Therefore, ensure that you have a high risk appetite looking for decent returns over a time horizon of 3-5 years.

PS:  If you are looking for quality mutual fund schemes to add to your investment portfolio, I suggest you subscribe to PersonalFN's premium research service, FundSelect. Currently, with the subscription to FundSelect, you could also get Free Bonus access to PersonalFN's Debt Fund recommendation service DebtSelect.

Under DebtSelect, we give high weightage to schemes displaying worthy portfolio characteristics. We avoid debt mutual fund schemes that aim for higher yields by taking undue higher credit risk with substantial exposure in instruments issued by private issuers.

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Warm Regards,
Divya Grover
Research Analyst

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