By Bhavana AcharyaCalendar 2018 started out on a cautious note for dynamic bond funds.
A tumultuous 2017 saw divided opinion on direction of interest rate among with that of debt funds.
But with debt markets firmly building in rate hikes in 2018, dynamic bond funds had to change strategy.Gilt yields, though, have been volatile in past year.
Influencing factors were numerous, both domestic and global.
By close of 2018, debt markets were expecting rate cuts exact opposite of start of year.
Dynamic bond funds have begun upping their gilt exposure, already making gains off rally in gilt yields in past few weeks.Well-timed riseDynamic bond funds are appearing to be betting on rates going lower or, at very least, not moving higher from here.
Their exposure to gilts has been climbing steadily in past three months.
The earlier months saw a sustained dip, apart from some tactical calls earlier in year.
To play duration game and gain from rate cuts, gilts are most amenable.
A higher share in these instruments indicates that funds are betting on yields rallying on rate cut expectations.Gilt exposure rising againDebt markets and gilt yields have grappled with several factors over past year.
A depreciating rupee, rising crude oil prices, rate hikes in US, and inflation risks stoked expectations of a rising interest rate scenario.
This did transpire to some extent and yields remained elevated.
Yields reached 8 per cent mark by September, when debt markets were gripped by a confidence crisis and liquidity crunch.But commentary from US Federal Reserve turned dovish, concerns surfaced over a slowdown in global growth, crude oil prices crashed from their peaks, and inflation was persistently low domestically.
All this led to debt markets now pricing in a falling rate scenario.
Gilt yields fell to 7.2-7.3 per cent by end of December 2018.Dynamic bond funds exposure to government securities climbed to 29 per cent in December 2018 (for funds which have declared December 2018 portfolios), a steady rise from September 2018.
Some funds even used volatility and high yields through year to accumulate instruments at lower prices and made gains when yields rallied from around November2018.Returns rallyThe rally in yields over past few weeks have allowed funds to make gains.
Rolling 3-month returns for these funds show that returns are up quite sharply in recent weeks.
From ranging around 2 per cent and lower for a long time, 3-month returns have shot up to 3-4 per cent in past few weeks.
This has also pulled up 1-year returns of dynamic bond funds, which had been flagging.It helped many dynamic bond funds recoup part of hit they took in 2017.
The more aggressive among these funds had bet against rate hikes even in 2017 given that indicators on rate direction were extremely uncertain.
1-year returns of these funds have improved quite well; this is thanks to both a shift to accrual earlier in year when interest rates werehigh and recent capital appreciation in gilt and bond prices.Of course, dynamic bond funds could be taking tactical calls, as they have done in earlier months as well.
The coming months could throw more light on strategy dynamic bond funds will follow and return potential they have.(Bhavana Acharya is Deputy Head of Mutual Fund Research at FundsIndia.com.
Views are her own)