Bond Funds That Play “Duration” For Capital Appreciation
Dynamic, meaning it can change according to your requirements. But, you might be wondering how such a word can apply in the context of investments.
Before understanding Dynamic Bond Funds’, we need to know about Dynamic Mutual Funds.
A dynamic mutual fund is a mutual fund that is dynamic in nature. It means that the fund manager can change the fund’s underlying instruments, such as stocks and bonds, to align with the current and future expectations of the fund.
The objective of this fund is to deliver optimum returns in falling and rising market cycles. Unlike a regular fund that looks to buy and hold the instruments for the long run, a dynamic fund aims to make the best out of the current market situation.
What are the Dynamic Bond Funds?
Dynamic bond funds are debt mutual funds that invest in debt or fixed-income securities such as government and corporate bonds. These funds are always open to investment and redemption.
The fund managers invest for different lengths of time depending on how they think interest rates will change.
Most of the time, dynamic bond funds are riskier than short- and medium-term bond funds. Still, they have the potential to give better returns in different interest rate scenarios and for long enough periods.
How do Dynamic Bond Funds work?
The Macaulay duration is the average weighted term to maturity of a fixed-income security’s cash flows. Macaulay Duration is, in simple terms, the weighted average number of years an investor must hold a position in a fixed-income instrument until the present value of the cash flows from the fixed income instrument equals the amount paid for the instrument. Macaulay duration is similar to another measure of duration called Modified Duration, often called Duration. Modified Duration is the change in the price of a bond for every 1% change in the interest rate. In other words, Modified Duration measures how sensitive fixed-income security is to changes in interest rates.
Dynamic bond funds can put their money in bonds with different maturities. The duration of a Dynamic Bond will depend on the types of securities the fund manager chooses to buy based on how they think interest rates will change in the future. If the fund manager thinks that interest rates will go down in the future, they will put money into bonds with a longer term (longer duration) to make money from the price going up. If the fund manager thinks that interest rates will go up in the future, they will buy shorter-term bonds to lower the risk of interest rate changes and re-invest the money from the bonds when they mature at higher interest rates.
How do Dynamic Bond Funds help in capital appreciation?
Dynamic asset allocation: Dynamic bond funds can invest in securities with a wide range of investment durations. In contrast to other debt funds, they are not subject to any investing mandates. They are not limited in their ability to invest in either short- or long-term securities. Their dynamic asset allocation also enables them to profit from changes in interest rates. They can buy long-duration securities in the event of lowering interest rates. They may invest in short-term securities in the event of rising interest rates.
No debt fund requirement: Dynamic funds don’t have to follow an investing mandate like other debt funds. For instance, only short-term securities may be purchased by short-term bond funds. Dynamic bond funds, on the other hand, are not subject to this limitation. They can also make a one-month investment in long-term securities. Interest rate changes are the center of the overall approach.
Advantages: Tax on Long Term Capital Gains(when debt fund remains invested for a period of 36 months or more) is taxed at 20% after allowing indexation benefits, thus leading to a huge reduction in taxable income and saving a large chunk of income tax.
Ideal for: These funds are ideal for investors who don’t want to actively take calls in making a decision based on interest rate movements.
This blog is purely for educational purposes and not to be treated as personal advice. Mutual funds are subject to market risks, read all scheme-related documents carefully.