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Choose Dynamic Bond Funds in Interest Rate Uncertainties
March 21, 2012

In its Mid-Quarter Monetary Policy Review held recently, the Reserve Bank of India (RBI) left key policy rates unchanged. Going forward, Interest Rates will depend on Inflation, which is a concern as crude oil prices are rising. In this article, we focus on Dynamic Bond Funds as they look attractive in volatile interest rate scenario.

Author : Danish Sayyed

Birla Sun Life Dynamic Bond Fund

Key Points:

  1. RBI left key policy rates unchanged in Mid-Quarter Monetary Policy Review held on 15 March 2012.

  2. Inflation risk remains, due to recent rise in crude oil prices, fiscal slippages and rupee depreciation.

  3. Interest Rates will depend on Inflation numbers going forward.

  4. In volatile interest rate scenario, Dynamic Bond Funds looks attractive.


The Reserve Bank of India (RBI) continues ‘pause’ in key policy rates after hiking it 13 times since March 2010. In its recent Mid-Quarter Monetary Policy Review, it has stated that falling of key policy rates would depend upon the inflation numbers going forward. The recent moderation in inflation has been seen mainly from the contribution of primary food articles as well as fuel and manufactured product groups. However, upside risks to inflation has increased from the recent rise in crude oil prices, fiscal slippage and rupee deprecation. On the other hand, the widening of fiscal deficit is also a major concern.



Uncertainty… Even in Fixed Income Markets!

The current situation of Indian Debt market is worrisome to investors who want to invest in Debt Funds. In the rising interest rate scenario, an investor can park their money in Short Term Funds whereas in the falling interest rate scenario, investors can park/stack in Long Term Debt Funds. But what does an investor do, in an uncertain interest rates scenario? The call on interest rates is difficult to take for an investor and hence they are confused to decide which fund to choose for investments. In this uncertain debt market scenario, Dynamic Bond Funds would be a prudent choice for investment. 

Chart 2: Yield of various Debt Securities


Dynamically Managed Bond Funds

As the name suggest, Dynamic Bond Funds are managed dynamically taking calls on interest rates by fund managers. They have the flexibility to change the average maturity and duration of the bond according to the interest rate scenario. In the changing interest rate scenario, fund managers have more flexibility to shift allocations and also to change the mix of underlying debt instruments like Corporate Debt, Certificate of Deposits, Commercial Papers, etc. Usually, they reduce the duration in rising interest rate scenario and increase it when rates fall or are expected to fall. Hence, this is said to be a good option for fixed income investors in a changing interest rate scenario.

Birla Sun Life Dynamic Bond Fund

Birla Sun Life Dynamic Bond Fund is a dynamic income fund which seeks to generate optimal returns through active management of portfolio by investing in bonds of quality companies to capture positive price movements and minimize the impact of adverse price movements.  The fund was launched in September 2004 and is currently managed by Mr. Maneesh Dangi since September 2007. The AUM of the fund on December 2006 was about Rs. 5 crores which progressively increased to Rs. 3,593 crores till December 2011.

Investment Strategy

Looking at the fund’s investment pattern for the period of 5 years from December 2006 to December 2011, investment strategy of the fund can be extracted. In the FY2008, when interest rates were stable, the fund had been invested in short term papers like Corporate Debts, and Certificate of Deposits. However during that year, months like May and August to October 2007, the fund had taken huge exposure in cash which was as high as 77% of the portfolio (May 2007). In September 2007, Mr. Maneesh Dangi took over the fund to manage, and since then the fund had reduced its huge exposure from cash to various Debt securities. On an average, it has about 2.30% allocation to cash in the period from January 2008 to December 2011.

In the first half of FY2009, there was a rise in inflation due to high oil prices and adverse domestic factors. The inflation for June 2008 came to 10.89% on a year-on-year basis, and remained in double digit for 5 consecutive months. The RBI took crucial measures by hiking interest rate by 125 basis points to tame the inflation. During this rising interest rates scenario, the fund manager continued investing in short term papers, playing with different debt instruments. The fund manager also brought down the average maturity from 241 days to 91 days.

In the second half of FY2009, Indian Market and Indian Economy were affected due to Lehman Brothers crisis. As the Indian Economy started slowing down RBI had to loosen monetary policy by lowering interest rates. During this period of softening in interest rates, the fund had increased the average maturity from 0.3 years (117 days) to 2.5 years. The fund manager added Corporate Debt and PSU & PFI Bonds during this period while investing its major chunk in Certificate of Deposits.

In the FY2010, the interest rates were paused and the fund had invested across all the debt securities. The fund also started taking exposure to Government Securities in November 2009. In FY2011, due to double digit inflation numbers, the RBI started hiking interest rates. In the rising interest rate regime, the fund gradually reduced its average maturity from 2.0 years to 0.9 years (332 days). From November 2010 to February 2011, the fund started taking major exposure in Corporate Debt and exited from Certificate of Deposits and Commercial Papers.  The allocation to Corporate Debt was about 56% on December 2010. The fund also had 12%-24% of cash in the portfolio from November 2010 to March 2011.

During the first nine months of FY2012, interest rate hikes continued as inflation was not under control and the fund started to increase the average maturity period from 1.5 years to 2.44 years, expecting the RBI to pause or to lower the interest rates. During the period, the fund continued to invest its major portion in Corporate Debt and also started adding Government Securities in July 2011. Chart 3 shows the Asset Allocation of the fund as on December 2011.

Overall, the fund has got average maturity period as low as 0.1 years (36 days) and as high as 4.3 years over the past four years.  Hence the fund is like short term fund in the industry, with an ‘absolute return’ bias.

Chart 3 – Asset Allocation as on December 2011



The fund has delivered good returns and outperformed its benchmark, i.e., CRISIL Composite Bond Fund Index as well as its peers. Over the period of 5 years, the fund has delivered CAGR returns of 9.22%, whereas its benchmark and average category has delivered CAGR returns of 6.25% and 6.84% respectively. If an investor had invested Rs. 10,000 on 31 December 2006 then on 31 December 2011, the investment amount would be worth Rs. 15,511. The fund performed well in both the rising and as well as falling interest rates scenario. Chart 4 shows the performance of the Birla Sun Life Dynamic Bond Fund compared to its category average and the benchmark index.

Chart 4 – Performance of BSL Dynamic Bond Fund and its Category Average and Benchmark Index


Our take on the fund

The fund’s ‘duration’ play in various interest rates scenario proves that it has been actively managed in lowering duration during ‘rising rate regimes’ and increasing the duration when the rates are expected to fall. This active management by the fund manager has proved to generate good returns.
The uncertainty of future interest rates has created a difficult situation for an investor to decide which fund to choose for investment. Birla Sun Life Dynamic Bond Fund has proved to perform well in all the interest rate scenarios by generating good returns by playing it “dynamically”.

iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual funds of any of the Asset Management Company mentioned or referred to in the article, and may from time to time add or dispose of, or be materially interested in any such. This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any mutual fund. No investment decision should be taken without first viewing a mutual fund's offer document/scheme additional information/scheme information document. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Investors should seek for professional investment, tax, and legal advice before making an investment or any other decision. Past performance and any forecast is not necessarily indicative of the future or likely performance of the mutual fund. The value of mutual funds and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer in the website.


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