3 Best Dynamic Bond Funds for 2024

December 14, 2023 Mutual Fund

The finance ministry recently admitted that inflation is still a risk, and the government and the RBI are on high alert for it.

Accordingly, in the recently held December 2023 bi-monthly monetary policy meeting, during the press conference in the opening remarks, RBI Governor, Mr Shaktikanta Das articulated that while significant progress is made in bringing down inflation, the future path is expected to be clouded by uncertain food prices.

Mr Das further stated that the six-member Monetary Policy Committee (MPC) will be on high alert to any signs of derailing the ongoing disinflation process. Thus, based on the evolving situation, the MPC will take appropriate action to reach the 4.0% inflation target.

According to the RBI, uncertainty in food prices along with unfavourable base effects, plus volatility in crude oil prices, pose risks to the inflation outlook.

The MPC will carefully monitor any signs of generalisation of food price pressures, which can fritter away the gains in easing core inflation.

In other words, the path to interest rates will be hinged on the CPI inflation trajectory. So far, the RBI has cumulatively hiked policy by 250 basis points (bps).

Graph 1: CPI Inflation v/s Interest Rates

Data as of November 2023
(Source: MOSPI, RBI, data collated by PersonalFN Research) 

CPI inflation for November 2023 increased once again to 5.55% (a 3-month high) after slowing (to 4.87%) in the previous month due to higher food prices.

In the December 2023 bi-monthly monetary policy meeting, the MPC considering the evolving macroeconomic and financial developments and the outlook, unanimously decided to keep the policy repo rate unchanged at 6.50%.

Further, it resolved to remain on withdrawal of accommodation to ensure that inflation progressively aligns with the target while supporting growth.

The RBI has stated that it is prepared to undertake appropriate and timely policy actions should the situation warrant. The MPC will remain resolute in its commitment to aligning inflation to the target.

In such times to play the interest rate cycle, you could consider investing in Dynamic Bond Funds.

You see, bond prices and interest rates are interlinked. Various macroeconomic factors, headline inflation, the interest rate cycle, and the central bank’s objective affect bond prices.

When interest rates and yields move up, prices of bonds go down and therefore, debt mutual funds, especially those holding longer maturity instruments, witness diminishing returns. Similarly, when interest rates fall, bond prices move up and so do the returns on your debt mutual fund.

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. In such a case, to ensure that you earn optimal returns during both rising and falling interest rate scenarios, Dynamic Bond Funds make sense.

What Are Dynamic Bond Funds?

These are a sub-category of debt mutual funds that invest in debt securities without a predetermined maturity profile or duration. In other words, Dynamic Bond Funds have the flexibility to shift investments between short-term, medium-term, and long-term debt securities, taking into consideration the interest rate cycle.

The capital market regulator, SEBI, categorises Dynamic Bond Funds as open-ended dynamic debt schemes that invest across the duration of debt securities.

Typically, Dynamic Bond Funds invest in short-term instruments, such as Commercial Papers (CPs) and Certificates of Deposits (CDs), or medium to long-term instruments, such as corporate bonds and gilt securities.

The fund manager allocates to short and longer maturity papers depending on the outlook on the interest rates and overall economy.

If the fund manager of a Dynamic Bond Fund is anticipating interest rates to fall, wherein locking in at higher interest rates is beneficial, higher allocation may be made to longer-duration debt securities. Conversely, in a rising interest rate, the fund manager may allocate more to short or low-duration securities.

Dynamic Bond Funds take a view of the interest rate cycle and bond yields to actively manage its portfolio.

What Is the Investment Objective of Dynamic Bond Funds?

Broadly, the primary investment objective is to provide optimal returns with high liquidity through an actively managed portfolio of high-quality debt securities across varying maturities (short-term and long-term) and money market instruments.

However, there is no assurance or guarantee that the investment objective will be realised.

Are Dynamic Bond Funds Safe?

The performance of a Dynamic Bond Fund largely depends on the fund manager’s judgement of the interest rate movement. If the manager fails to gauge the movement of interest rates accurately or is unable to time the investment precisely, investors may suffer losses.

Moreover, there is an element of credit risk involved. If the fund manager of a Dynamic Bond Fund invests in low-quality debt papers to engage in yield hunting, it may expose its investors to high risk. So, a lot depends on the portfolio characteristics of the scheme you decide to add to your portfolio.

Graph 2: Risk-Return Spectrum of Debt Mutual Funds

For illustration purposes only
(Source: PersonalFN Research) 

By and large, Dynamic Bond Funds are placed at the higher end of the risk-return spectrum. For it to be a rewarding experience for you, selection matters.

How to Choose the Best Dynamic Bond Funds to Invest in?

Avoid zeroing in on Dynamic Bond Funds to invest in looking at just the past returns because they are in no way indicative of future returns. Similarly, you cannot go by star ratings given based on historical performance, as it isn’t foolproof.

[Read: Relying on Star Ratings to Pick Best Mutual Funds? Read This]

To make the best choice, you need to evaluate a host of quantitative and qualitative factors, such as…

• The portfolio characteristics (who are the issuers, the sector they belong to, the type of debt papers held, the ratings of the respective debt papers, etc.)
• The allocation to maturity profiles (short, medium, and long-term) of the debt portfolio
• The Yield-To-Maturity (YTM) and the Modified Duration (MD) of the portfolio
• The risk ratios (Standard Deviation, Sharpe Ratio, Sortino Ratio, etc.) to understand if the scheme is adequately compensating on a risk-adjusted basis
• The performance across interest rate cycles
• The credentials of the fund manager and his team
• The AUM and expense ratio of the scheme

Also, it would be meaningful to understand the investment ideologies and the investment processes & systems followed at the fund house.

A fund house must have a robust risk management framework in place, and not dependent excessively on the ratings assigned by credit rating agencies.

Ideally, in the attempt to achieve its stated investment objective, a Dynamic Bond Fund should not be investing in low-rate debt securities and engage in yield hunting, or else it could expose you, the investor, to higher risk and jeopardise the liquidity of the portfolio.

It is critical to invest in Dynamic Bond Funds that hold a robust portfolio of securities across maturities and high-quality debt & money market instruments.

Which Are the Best Dynamic Bond Funds for 2024?

Considering the facets discussed above, the three best Dynamic Bond Funds currently for 2024 are:

1) SBI Dynamic Bond Fund

2) Quantum Dynamic Bond Fund

3) JM Dynamic Bond Fund

These schemes hold quality portfolio characteristics with higher exposure to longer-maturity papers. Perhaps the fund managers of these schemes are viewing interest rates currently near the peak and expecting them to decline going forward (if inflation pressure eases, allowing the RBI to turn accommodative in its stance).

Table 1: Performance of Dynamic Bond Funds

Performance as of December 11, 2023. Returns are Point to Point and in %, calculated using the Direct Plan-Growth option.
Standard Deviation indicates Total Risk and Sharpe Ratio measures the Risk-Adjusted Return. They are calculated over 3 years assuming a risk-free rate of 5% p.a.
Past performance is not an indicator of future returns.
*Please note, that this table only represents the best-performing schemes based solely on past returns.
The securities quoted are for illustration only and are not recommendatory.
Speak to your investment advisor for further assistance before investing.
Disclaimer: Quantum Liquid Fund is a scheme from Quantum Mutual Fund, a group company of Quantum Information Services Pvt. Ltd.
PersonalFN is not in receipt of any commission directly or indirectly for suggesting the scheme.
Mutual Fund investments are subject to market risks. Read all scheme-related documents carefully. 

Here are the details as to why SBI Dynamic Bond Fund, Quantum Dynamic Bond Fund, and JM Dynamic Bond Fund are among the best Dynamic Bond Funds.

Best Dynamic Bond Fund for 2024 #1: SBI Dynamic Bond Fund

Launched in January 2004, the SBI Dynamic Bond Fund (SDBF) is one of the oldest schemes in the dynamic bond funds category that has a performance history of over 19 years to its credit.

Over its years of existence, SDBF has been through several interest rate cycles over the years. It has the mandate to dynamically change the portfolio duration depending on the prevailing interest rate conditions.

The fund’s investment objective is to provide investors with attractive returns through investment in an actively managed portfolio of high-quality debt securities of varying maturities.

In the endeavour to achieve its investment objective, SDBF actively manages its portfolio. It holds debt securities across maturities and issuers.

As per its latest portfolio as of November 2023, SDBF is holding a predominant portion (72.6%) of its net assets in Government securities (G-secs), some 13.2% in corporate debt, 0.2% in an Alternative Investment Fund (namely, the Corporate Debt Market Development Fund), and the rest, i.e., 13.9% of its net assets is in cash-and-cash equivalents. The higher allocation to cash-and-cash suggests that SDBF takes active and aggressive cash calls on the interest rate movements.

Currently, perhaps assessing that the interest rate cycle has almost peaked, SDBF has deployed its assets largely in 5 to 7 years and 7 to 10 years maturity buckets comprising nearly 65% of its net assets. Over and above, SDBF also holds around 14.9% in 10 years and above the maturity bucket.

The average maturity of SDBF at present is around 8-9 years, higher than some of its category peers. Hence, SDBF’s sensitivity to interest rate movement is on the higher side.

As far as the rating profile is concerned, SDBF primarily invests in AAA and equivalents and sovereign-rated G-secs. At times, it holds some exposure to high-rated money market instruments like CDs and CPs. Thus, the credit quality of the portfolio is high.

Table 2: Top-10 Holdings of SBI Dynamic Bond Fund

Data as of November 30, 2023
(Source: ACE MF, PersonalFN Research) 

As per the portfolio as of November 2023, SDBF has 17 securities in its portfolio. The top 10 holdings account for 77.7% of the fund’s assets. So, it holds a portfolio of debt securities with conviction.

Since its inception in January 2004, the fund has clocked a compounded annualised return of around 5.9% as of December 11, 2023. As seen in Table 1, on 2 years, 3 years, and 5 years returns, SDBF has clocked appealing compounded annualised returns, higher than the category average and better than the Crisil Composite Bond Fund Index. The fund has played the interest rate cycle well by holding quality debt papers across issuers with higher maturity papers.

SDBF has exposed its investors to lesser risk (as denoted by the Standard Deviation). Thus, on a risk-adjusted basis, SDBF has rewarded its investors with superior risk-adjusted returns as indicated by its Sharpe ratio of 0.03 and Sortino Ratio of 0.06.

Overall, SDBF is an above-average performer that has outperformed the Crisil Composite Bond Fund index as well as many of its category peers across various time periods with an expense ratio of 0.6% under the Direct Plan and 1.43% under the Regular plan, which is reasonable compared to some of its category peers.

SDBF currently carries a YTM of 7.52%. This is the return if the underlying debt securities are held till maturity. The YTM could change as the fund manager buys and sells securities in the portfolio.

SBI Dynamic Bond Fund is managed by Mr Rajeev Radhakrishnan and Mr Tejas Soman with effect from December 1, 2023. Before that, Mr Dinesh Ahuja was managing the fund since January 2011.

Mr Radhakrishnan has over 22 years of experience in the Asset Management industry with around 20 years of experience in fixed-income funds management and dealing. Over this extensive experience in the asset management industry, he has managed Fixed Income products across liquid, money markets, hybrid, and active duration across various credit and interest rate cycles.

He is currently the CIO – Fixed Income at SBI Mutual Fund and manages some of the flagship funds of SBI Mutual Fund. Mr Radhakrishnan is an Engineering graduate (B.E.) and holds a Master’s degree in Finance from Mumbai University. He is also a Charter holder of the CFA Institute, USA. Mr Radhakrishnan is currently a member of the IRDAI consultative committee on Investments.  He is also a Board member of the Indian Association of Investment Professionals (CFA India Society) & a member of the AMFI valuation committee.

Mr Soman is a Fund Manager – Fixed Income at SBI Mutual Fund. He joined SBI Mutual Fund in February 2020, and before that worked with Yes Bank, responsible for managing its sales portfolio consisting of Government Bonds, State Development Loans and Treasury Bills. Mr Soman is a postgraduate in Securities Markets and Investments from the National Institute of Securities Market and is a commerce graduate (B.Com) from the University of Mumbai.

Best Dynamic Bond Fund for 2024 #2: Quantum Dynamic Bond Fund

Quantum Dynamic Bond Fund (QDBF), launched in May 2015, holds a flexible investment mandate. It holds allocation across maturities and shifts portfolio duration based on the fund manager’s outlook on macroeconomic factors and interest rate direction.

The investment objective of QDBF is s to generate income and capital appreciation through active management of a portfolio consisting of short-term and long-term debt and money market instruments.

The fund focuses on investing only in government securities, Treasury-bills (T-bills), and the highest quality corporate debt instruments issued by Public Sector Undertakings (PSUs), which are shortlisted under the proprietary credit research and review process of the fund house.

Following high safety norms, the fund manager strictly resists investing in instruments issued by private issuers that could expose investors to higher credit risk. QDBF does not engage in yield hunting. Note, that there are only a few Dynamic Bond Funds that focus on safety over returns, irrespective of whether they make it to the list of category outperformers or not and QDBF is one of them.

Since the beginning, the QDBF has been focusing only on top-notch government and quasi-government securities. Even at present (as per the latest portfolio as of November 30, 2023), QDBF holds 90.3% of its net assets in Government securities. Only 5.4% is held in corporate debt, 0.2% in an AIF (namely the Corporate Debt Market Development Fund) and the remaining 4.0% is in cash-and-cash equivalents.

Currently, taking a view of the interest rate environment, QDBF has held 53.5% of its assets in the 7 to 10 years maturity bucket, 5.3% in the 10 to 15 years maturity bucket, and 26.3% in the above 15 years maturity bucket. Thus, around 85.1% of its assets are held in longer maturity buckets.

The average maturity of QDBF is around 14 years at present, noticeably higher than some of its category peers. As the fund takes duration calls depending on its assessment of the market outlook, it comes with a slight interest rate risk and may show some volatility in a rising interest rate scenario.

Speaking of the rating profile, QDBF predominantly holds sovereign-rated G-secs plus the AAA and equivalents. The fund has no exposure CDs and CPs. Thus, it holds a very respectable credit-quality debt portfolio.

Table 3: Top-10 Holdings of Quantum Dynamic Bond Fund

Data as of November 30, 2023
(Source: ACE MF, PersonalFN Research) 

QDBF holds a compact portfolio of 5 to 15 securities consisting mainly of G-secs along with corporate debt instruments issued by PSUs. Its latest portfolio as of November 2023, has 7 debt securities, mainly dominated by G-secs. These comprise nearly 96.0% of the fund’s assets. Given the small size of the fund, holding a compact portfolio seems sensible.

Since its inception in May 2015, QDBF has clocked a compounded annualised return of around 7.6% as of December 11, 2023. While QDBF has trailed the benchmark index and the category average over the 5 years, it has done relatively better in the last 2 years and 3 years, where it has managed to outperform the index and the category average returns.

QDBF has exposed its investors to lesser risk (as denoted by the Standard Deviation) and has generated adequate risk-adjusted returns for its investors.

Overall, QDBF is a decent performer with an expense ratio of 0.5% under the Direct Plan and 1.0% under the Regular Plan, which is quite competitive compared to its category peers.

Quantum Dynamic Bond Fund is managed by Mr Pankaj Pathak (since March 2017).

Mr Pathak is a Fund Manager – Fixed Income at Quantum Asset Management Company (QAMC) and has over 13 years of experience in Fixed income investments and research. Mr Pathak joined QAMC in August 2013, and at present, he also manages the Quantum Liquid Fund. He holds a Post Graduate Diploma in Banking & Finance from the National Institute of Bank Management (NIBM), Pune, and is a qualified CFA (Chartered Financial Analyst).

Best Dynamic Bond Fund for 2024 #3: JM Dynamic Bond Fund

JM Dynamic Bond Fund (JDBF) was launched in June 2003. JDBF aims to actively manage a portfolio of good quality debt as well as money market instruments to provide reasonable returns and liquidity to the unitholders/investors.

The fund has the mandate to park its net assets mainly in G-secs, corporate debt, and money market instruments. That said, the fund may also invest some portion into CDs and CPs at an opportune time.

As a strategy, JDBF allocates its assets in various maturities based on the expected interest rate scenario. And since the interest rates can be volatile at times, the fund endeavours to invest in highly liquid debt and money market instruments. JDBF follows an active duration management strategy because of which the portfolio turnover could be high.

At present (as per the latest portfolio as of November 30, 2023), the fund manager is taking aggressive cash calls by holding 36.2% in cash-and-cash equivalents. This indicates the fund manager is actively playing the interest rate cycles. The fund currently has 40.6% in G-secs, 22.9% in Treasury Bill (T-bills), and 0.3% is held in an AIF (namely, Corporate Debt Market Development Fund).

JDBF is currently holding 26.6% of the corpus in the 7 to 10-year maturity bucket, 22.9% in the 3 to 6-month bucket, 11.7% in the 3 to 5-year bucket, and 2.3% in the 5 to 7-year bucket.

Speaking of the ratings profile, JDBF predominantly holds sovereign-rated G-secs and the remainder is held in cash-and-cash equivalents.

Table 4: Top-10 Holdings of JM Dynamic Bond Fund

Data as of November 30, 2023
(Source: ACE MF, PersonalFN Research) 

Its latest portfolio as of November 2023, JDBF has 7 debt securities, mainly dominated by G-secs. These comprise nearly 63.7% of the fund’s assets. Given the smaller AUM worth Rs 42.95 crore, the fund seems to be holding a compact portfolio and currently sitting on 36.2% cash-and-cash equivalents.

Since its inception, the fund has clocked a compounded annualised return of around 6.5% (as of December 11, 2023). While JDBF has trailed the Crisil Composite Bond Fund Index and the category average over the 5 years, it is slightly better in the last 2 years and 3 years, wherein it has managed to outperform the Crisil Composite Bond Fund Index.

JDBF has exposed its investors to lesser risk (as denoted by Standard Deviation) and adequately compensated returns on a risk-adjusted basis. Overall, it has a decent performance track record. The fund has a very competitive expense ratio of 0.6% under the Direct Plan and 0.9% under the Regular Plan.

JM Dynamic Bond Fund is currently managed by Mr Gurvinder Singh Wasan and Ms Shalini Tibrewala (with effect from April 2022). Before that, JDBF was co-managed by Mr Prashant Pimple and Ms Tibrewala.

Ms Tibrewala has over 25 years of experience in the financial services sector. She has been with the Fund for 25 years. Before joining the AMC, she was working with a firm of Chartered Accountants. At JM Mutual Fund, she manages several other debt mutual fund schemes. She has been associated with JM Financial Asset Management since 1997. She is a graduate in commerce with an honours degree [B. Com(H)], a Chartered Accountant (CA) and Company Secretary (CS) by qualification.

Mr Wasan has over 19 years of experience in the fixed-income markets. His previous assignments included working as a Fund manager and a credit analyst with a mutual fund and as a structured finance manager with a rating agency and a bank. At JM Mutual Fund, he also manages the debt portion of the equity schemes. Mr Wasan is a postgraduate in commerce (M.Com), a Chartered Accountant (CA), and a CFA Charter holder.

Overall, these three Dynamic Bond Funds follow appropriate risk management measures and have rewarded investors. They are from fund houses that follow robust investment processes and systems.

The 5 Key Benefits of Investing in Dynamic Bond Funds Are…

1) Reduces interest rate risk through active management of portfolio based on interest rate outlook

2) No need to time the entry and exit in the debt market because fund managers take care of it

3) Offers a solution for your long-term debt investment needs

4) Acts as a tax-efficient instrument in the form of indexation benefit on long-term capital gain

5) Earns better returns and higher liquidity than Bank FDs

Who Should Invest in the Dynamic Bond Funds?

Dynamic Bond Funds are suitable for investors who want to benefit from both rising and falling interest rate cycles, with a professional debt fund manager doing it for them.

Dynamic Bond Funds, regardless of the direction interest rates move, are capable of taking advantage of dynamic market conditions and can invest accordingly to create an all-season portfolio that generates optimal returns.

Dynamic Bond Funds can be an alternative to investing in long-term bank FD. That being said, the investment cannot be considered safe or risk-free (like in the case of an FD with a robust bank). Remember, Dynamic Bond Funds are sensitive to interest rate changes and thus may witness some volatility, typically in a rising interest rate scenario. However, with a longer investment horizon, the volatility fades out. Thus, ensure you have a time horizon of at least 3 to 5 years and can tolerate fluctuations to earn market-linked returns.

[Read: Exploring Alternatives to Bank FDs – A Deep Dive into Debt Funds]

What Are the Tax Implications of Investing in Dynamic Bond Funds?

For all debt funds, with effect from April 1, 2023, the capital gain arising at the time of redemption — whether short-term (a holding period of less than 36 months) or long-term (a holding period of 36 months and above) — is taxed as per investors’ tax slab.

The indexation benefit that earlier helped to make the most of the inflation impact on the purchase value of the investment and effectively reduced the LTCG tax liability is now no longer available for Debt Mutual Funds.

[Read: Debt Mutual Funds are Now at Par with Fixed Deposits for Taxation]

For NRIs, the capital gains on debt-oriented mutual funds are subject to Tax Deduction at Source (TDS) at the rate of 10% for LTCG and 30% for STCG.

If you have opted for the dividend option (now known as IDCW option), for resident Indians, any dividends from Dynamic Bond Funds (under the Dividend Option) are added to the investors’ total income and are taxed according to your income-tax slab, i.e., at the marginal rate of taxation. However, if the dividend amount is more than Rs 5,000, Tax Deduction at Source (TDS) will be first done at the rate of 10%. For NRIs, the dividend received is taxed at the rate of 20%.

To sum-up…

When investing in Dynamic Bond Funds, you will be exposed to interest rate risk, credit risk, and liquidity risk. The level of risk shall depend on how well the fund manager understands and plays the interest rate cycle and the quality of debt papers held. Therefore, avoid simply looking at past returns and mutual fund star ratings.

Be a prudent investor and consider your risk appetite, investment objective, and investment horizon before investing in any mutual fund. Be thoughtful in your approach. And when in doubt, speak to a SEBI-registered investment advisor.

Happy Investing!

This article first appeared on PersonalFN here