By R Balachandran
Fixed income mutual fund investors have been a harried lot of late. The last one year has been a truly vexing time. Liquid and short-term funds produced abysmal returns, barely outpacing inflation. The carnage in the bond markets with yields shooting up by about 100 basis points resulted in returns in the range of 1-2 per cent for most of the long duration funds. Even that tiny gain was taxable. At the same time, the equity investor even in basic index funds earned about 28 per cent tax-free returns thanks to the erstwhile zero long-term capital gain regime and, of course, the overall market performance. Talk about neighbour’s envy!
Enter the class of debt mutual funds — the dynamic bond schemes — which aim to provide “optimal” returns in market scenarios of both rising and falling interest rates, by “active” management of the portfolio. Such funds have sizable assets under management with each AMC having a portfolio of several thousand crores in this category.
The last one year served as an acid test for such dynamic bond funds which go by various other names too like strategic, flexible income funds, etc. Benchmark 10-year bond yields, which went all the way down to 6.2 per cent post demonetisation, reversed course in the face of rising oil prices, threat of slippage in fiscal deficit and expected oversupply in bond markets owing to the announcement of the issuance of Rs 1.35 lakh crore bank recapitalisation bonds. Yields went through the roof and touched 7.5 per cent. So, how did dynamic bond funds fare in this scenario?
An analysis of the returns of dynamic bond funds of some of the larger fund houses reveals a bleak picture. Returns have largely mirrored that of long duration funds, with yields in the range of 1-2 per cent, though a few funds have done better. But not a single dynamic bond fund’s return came anywhere near the liquid fund yield of about 6.5 per cent from its own fund house.
Time to introspect
The volatile market conditions of the last one year should have provided the fund manager an ideal environment to prove his/ her mettle by “actively” managing the portfolio as declared in the scheme objectives, to provide reasonable returns to the investor. Not having lived up to investor expectations, fund managers need to introspect about the futility of trying to time the markets. The “fund manager speak” in the scheme information documents apart, the dynamic bond fund manager in effect takes a call on the movement in market interest rates. These are closely linked to the rate of inflation. Oil prices have an outsized role on the inflation trajectory in a country like India which imports most of its needs. Perhaps a short-term stint at the oil trading desks in London, New York or Singapore of the leading players in this commodity would help fund managers forecast oil prices, hence inflation and interest rates!
That’s only one part of the inflation story. Monsoon and weather conditions influence inflation in food prices. There are many other factors affecting inflation rates. In the face of such imponderables in predicting interest rate movements and the collapse in the portfolio returns in the recent past, fund houses need to introspect on the objectives of the dynamic bond schemes, the portfolio strategy, and if it makes sense, to continue this offering to their investors.
What can investors do?
Investors can learn some lessons from the dismal performance of the professional fund managers in a futile attempt to time the markets. Be it equity, bond, commodity or foreign exchange markets, no one can consistently time them. The Systematic Investment Plan investment route in equities helps investors in mitigating volatility in the stock markets. Taking the SIP route for investing in dynamic bond funds negates the raison détre of these funds.
Dynamic bond funds have not added value to the fixed income portfolios of investors in addressing volatile or adverse bond market conditions. Existing investors in these funds need to take a hard look at continuing their allocation to them. To keep it simple, investors can stick to short-term debt funds, which have withstood the test of time. They carry the added advantage of significantly lesser expense ratios when compared with dynamic bond funds, adding to the overall returns.
(The author is an expert on corporate banking and debt mutual fund investments)
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