Investment in debt assets is an essential part of a balanced portfolio with suitable asset allocation. Often, investors assume debt investments are not worth as their returns are nowhere matching with that of equity investments. However, they forget that interest rate scenarios along with macro-economic factors play an important role in deciding the returns you make out of your debt investments. And the fact that the interest rate scenario does not remain the same all the time, is an indication that returns from debt assets may, at times, be more rewarding than the other asset classes including equity.
Given the current fixed income outlook in the background of high inflation and rising interest rates, it is very likely that interest rates may continue to remain in the uptrend in the near future and then pause. Once the inflation taming measures show its desired impact, rate cycle could reverse. As an investor, instead of waiting on the side lines for various scenarios to play out, it is better to be invested in a fund which can gain from the market moves irrespective of where we are in a debt cycle.
Thus, an evergreen debt fund which stays relevant across the rate cycles by dynamically managing the portfolio can be apt to harness the potential of debt instruments over the long term. Such a category of debt fund is known as the Dynamic Bond Fund. Here, the fund will invest in debt and money market instruments — corporate bonds, government securities and others; with varying durations. Further, such funds do not have any restrictions when it comes to duration or maturities of the securities they invest in. So they invest across durations in accordance with the interest rate scenario and the opportunities available in the debt market.
The dynamic nature of the fund enables the fund manager to take a call on durations in an active and effective manner. In case there are expectations that interest rates will go down, fund managers have the freedom of investing in longer duration bonds to get the higher yield. On the contrary, if interest rates are expected to go up, shorter duration bonds are invested in to get the low yield, thus making the dynamic bond fund category a winner across the rate cycles.
As an investor, it is necessary to stay invested for atleast three years and more in such a fund to benefit from the investment calls taken given that they will take some time to completely play out. This is suitable for an investor with a moderate risk appetite. Within the dynamic bond fund category, there are offering from several fund houses. Amongst these one of the names which has been largely consistent in terms of the investment experience is the ICICI Prudential All Seasons Bond Fund.
What makes the fund stand out is that the portfolio calls are taken basis an in-house model. The portfolio is typically diversified across corporate bonds and Government papers and has the ability to manage duration in the range of 1-10 years. For duration calls, the fund relies on an in-house model and is actively managed. This in-house model takes into consideration macro factors like interest rates, current account deficit, fiscal deficit, credit growth etc. Whenever the index level as per in-house valuation model start moving into positive territory, the scheme increases duration and vice versa. Historical trends suggest that the scheme largely follows the value investing principle when it comes to portfolio construction.
In terms of the portfolio, the scheme has sizeable exposure towards spread assets for better accrual income and a good mix of instruments which benefits from higher term premium and better liquidity. Typically, when interest rates are high, the scheme behaves like a long duration scheme and when interest rates are low, the scheme behaves like an accrual scheme. Based on interest rate scenario, the fund manager decides on investing between corporate bonds and G-Secs. Also, from a tax efficiency point of view, the fund holds up pretty well against traditional investment avenues available.
To conclude, if you are an investor who is unsure how to navigate through the debt allocation in your portfolio, then you may consider investing in a dynamic bond fund wherein the fund manager will allocate your money prudently in pockets which are likely to deliver robust returns over the long term.