Of late with more investors realizing the importance of financial planning, dynamic funds are gaining lot of credence. Many small investors are finding dynamic funds as a means to hit two birds with one stone. Normally, the asset allocation onus is on the investor and they need to decide on whether they should add on to equity funds or to debt funds. More often, retail investors do not have the expertise to take such decisions. That is where dynamic funds are coming handy. Let us understand the benefits of dynamic funds and the best dynamic mutual funds available. The big question that investors have is “Should I invest in dynamic bond funds at all”? But first the idea behind dynamic funds!
Understanding all about dynamic bond funds
A dynamic fund, as the name suggests, gives a lot of discretion to the fund manager to tweak the asset allocation based on their view of the markets. Broadly, there are 3 categories of dynamic funds that are available in India.
Dynamic Equity Funds
Dynamic Equity Funds keep changing the mix of equities based on the fund manager view on equity macros. In that sense they are the complete opposite of diversified funds which operate on a set framework. For example, a dynamic equity fund may choose to go heavy on a particular sector or theme. It may also choose to increase the exposure to mid caps and small caps. Most of these are judgement based and depend largely on the discretion of the fund manager. The idea of a dynamic equity fund is to generate alpha through more aggressive sector and stock selection.
Dynamic Bond Funds
Dynamic bond funds tweak between different classes of bond portfolios. For example, if the expectation is that the rates are going to fall then the fund manager will shift his portfolio to the longer end of the tenure curve. The reverse is true if his view is that the rates are going to fall. Dynamic Bond fund managers also shift between credit qualities to enhance returns based on risk perceptions.
Dynamic asset allocation funds
These dynamic asset allocation funds actually switch between debt, equity and liquid funds to get the best asset class mix. In fact, some of the dynamic allocation funds fluctuate between 100% equity and 100% debt based on market conditions. Dynamic asset allocation funds can be useful for financial planning. In case you have zeroed in on your asset allocation, you can select a dynamic fund with the appropriate risk matrix. This way you only need to track a single NAV for your entire financial plan as compared to a plethora of NAVs.
Do dynamic funds make a difference to your portfolio?
There are 5 things we need to understand about dynamic funds and that is crucial in making the best of this product.
Any dynamic fund relies extensively on the discretion of the fund manager. The decision to tweak allocations to equity, debt and asset classes largely rests with the fund manager. Judgements are always prone to error and that needs to be factored in when you opt for a dynamic fund.
Dynamic funds, by definition, require a lot of churning. Frequent churning of portfolio has two implications. Since mutual funds are long term instruments, churning leads to opportunities being lost. Secondly, there is a cost implication to churning in the form of transaction costs and statutory costs.
If one were to look at returns of a diversified funds versus dynamic equity funds and dynamic allocation funds, then diversified funds have outperformed over different time frames. Consider the table below:
Source: Value Research
Would SIP on dynamic funds better the returns on a diversified fund? Typically, diversified funds have performed in bull markets that means SIPs on diversified funds will also perform better in bull markets. In a bear market, the diversified funds have a natural advantage as you reduce your cost of holdings automatically.
There is one area where dynamic funds can be of help and that is if you want to use as a proxy for your financial plan. Your financial plan is a mix of equity, debt and liquid funs and that can be achieved in a single dynamic asset allocation fund. You get two advantages here. Firstly, there are not tax implications when the portfolio is churned as the mutual fund, being a trust, does not attract tax. Secondly, you just need to track a single NAV for you entire personal financial plan.