Birla Sun Life Dynamic Bond Fund: Deft switching helps cap losses

After frontloading its rate cuts for the year to its earlier review, the RBI paused in its monetary policy review last week.

Given the uncertainty over rate hikes by the US Fed as well as the fiscal deficit target for the year, the RBI will perhaps resume its rate cuts only after the Budget early next year.

Given this uncertainty, it may be good idea for investors to consider dynamic bond funds for their debt portfolio, which can switch between short- and long-term debt instruments.

The actively-managed Birla Sun Life Dynamic Bond Fund is a good option here. Aside of government bonds, the fund also invests in corporate bonds, mainly AAA-rated ones. The fund is one of the top performers in its category across rate cycles and has beaten its benchmark by 1-1.3 percentage points over three- and five-year time-frames.

Over a five-year period, it has returned 9.8 per cent annually, placing it among the top funds in its category.

As longer duration bonds are more sensitive to interest rates, the fund manager increases or decreases the duration of the fund, depending on the interest rate scenario.

The fund actively changes its portfolio duration to make the most of rate cycles and this flexibility is quite useful now, given the uncertainty on further rate declines. For one, despite the RBI’s 125-basis-point cut in the repo rate since January, the yield on the 10-year government bond has been rock steady, at 7.7 per cent, since the beginning of the year.

Until the steep 50-basis-point rate cut by the RBI in its September policy, the markets had been tempering their rate cut expectations, which exerted upward pressure on the yield.

In recent weeks, the yield has, in fact, hardened further, in line with the rise in US bond yields.

The possible overshoot on the Centre’s fiscal deficit after the payouts under the Seventh Central Pay Commission, has also kept market bond yields high. Thus, top-performing gilt funds have delivered just 6-8 per cent so far this year, after their excellent run in 2014 (15-17 per cent returns).

Two, while the yield on 10-year G-Secs is still 1 percentage point higher than the RBI’s key policy rate (at 6.75 per cent), a sharp rally in bond prices, as seen in 2014, is unlikely. In 2014, the yield on 10-year G-Secs fell 1 percentage point.

While the current yield at 7.7 per cent is attractive, and investors with a long-term horizon will benefit from a downward rate cycle, the yield can fall to 7-7.25 per cent, at best, in the coming months.

Thus, given the uncertainty over the timing of the next rate cut, funds such as Birla Sun Life Dynamic Bond Fund can help investors cash in on rallies as well as cap losses in the event of a sudden spike in yields.

The fund has managed its duration calls well. From about 2.5 years, in early 2014, the fund increased its duration to five-six years by the end of the year.

This helped it deliver a 15 per cent return in 2014, almost 3 percentage points higher than its category.

The Dynamic Bond Fund has also reduced duration promptly when rates were on the rise.

It scaled down its duration in the beginning of 2015, and has gradually been increasing it in recent months. It has registered a 7.6 per cent return so far this year — nearly 60 basis points higher than the category average.

Over the last two to three years, the fund has invested about half its portfolio in government bonds and a third in corporate bonds. In 2014, to make use of the bond rally, the fund took its investment in government bonds to over 80 per cent. It currently holds about 79 per cent in G-Secs and about 16 per cent in corporate bonds.

The fund has a long duration of about seven years, which pegs up its interest rate risk. But it has the flexibility to tide over the uncertainty in interest rate movements.

Its ability to take the right calls makes it a good bet for investors at this juncture.

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