Do not invest in dynamic bond funds!

Published: May 26, 2015 at 3:01 pm

Last Updated on April 22, 2016

Dynamic bonds are debt mutual funds with a flexible investment strategy. There is a perception that they funds can be used to take advantage of interest rate movements to maximise gains.  Unfortunately, these funds do not reward investors enough for the effort and risk involved in its investment strategy. Which is why I believe that one should not invest in dynamic bond funds.

Investment strategy: Typically, when the interest rates are expected to fall, the fund manager will increase exposure to long-term bonds. When the interest rates are expected to increase, the fund manager will move to short-term bonds.

Such a strategy combines the two ways in which debt funds produce returns: capital gains (due to rate movements) and interest income from bonds.

A couple of days ago, I had mentioned that debt funds which invest in short-term bonds out-perform other categories including dynamic bond funds. Read that post here.

In this post, I would like to highlight the performance of dynamic bond funds with the same data set.

Plotted below is the CAGR calculated from annual returns from Value Research versus the standard deviation of the annual returns for different durations.

CAGR is the average rate at which an investment has compounded annually – a measure of reward.

Standard deviation is the extent of deviation of each annual return from the arithmetic average – a measure of risk.

The data points represent all debt mutual funds. Dynamic bond funds are shown in red.

12-year CAGR vs. 12-year standard deviation

dynamic-bond-funds-1Only two 12 -year old dynamic bond funds. They have done better than long-term funds: typically same reward at much lower risk. However, the short-term fund have done better.

If dynamic funds had indeed played the interest rate cycle well, they should have beat the short-term fund as well.

10-year CAGR vs. 10-year standard deviation


Again the same conclusions as above.

5-year CAGR vs. 5-year standard deviation


Short-term funds have done well in the last five years when rates were high. So should have dynamic bond funds if they had had enough exposure to short-term funds.  No evidence of that.

Conclusion: Stay away from dynamic bond funds. They are better than long-term funds. That is all that can be said. However, that is like saying a rock is better than a hard place!

Long-term funds are not of much use. They lose during rate hikes what they gain during rate cuts.  Dynamic funds fare better because of their ‘dynamism’ but have not managed to outperform short-term funds.

As mentioned at least thrice earlier(!), investors who stick to short-term funds are more than likely to do much better.

Do share if you found this useful

Did you know? We have more than 900+ videos on YouTube to explore! Join our YouTube Community!

Use our Robo-advisory Excel Template for a start-to-finish financial plan!

Join our courses in exclusive Facebook Groups!

  • 500+ members are now part of our new course, How to get people to pay for your skills! (watch 1st lecture for free). Learn how to get people to pay for your skills! Whether you are a professional or small business owner wanting more clients via online visibility or a salaried person wanting a side income or passive income, we will show how to achieve by showcasing your skills, building a community that trusts you and pays you!
  • 1822 members have signed for Goal-based portfolio management (watch 1st lecture for free). This is an online course to reduce fear, uncertainty and doubt while investing for a financial goal. Learn how to plan for your goals before and after retirement with confidence.

Want to check if the market is overvalued or undervalued? Use our market valuation tool (will work with any index!) or you buy the new Tactical Buy/Sell timing tool!
We publish mutual fund screeners and momentum, low volatility stock screeners on a monthly basis
About the Author Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association, IIST Alumni Association. For speaking engagements write to pattu [at] freefincal [dot] com
About freefincal & its content policy Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on developments in mutual funds, stocks, investing, retirement and personal finance. We do so without conflict of interest and bias. Follow us on Google News Freefincal serves more than one million readers a year (2.5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified from credible and knowledgeable sources before publication. Freefincal does not publish any kind of paid articles, promotions or PR, satire or opinions without data. All opinions presented will only be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions, seek the right answers and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now. It is also available in Kindle format.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at low cost! Get it or gift it to a young earner

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step. Get the pdf for Rs 199 (instant download)
Free android apps