The Indian economy was already under the spell of a prolonged slowdown when it was hit by the pandemic and the resultant lockdown. Since 2018, India GDP growth has been on a downhill and now it has contracted -23.9% in Q1FY21, the worst in over four decades. The COVID-19 pandemic has been catastrophic to India’s and several nation’s GDP growth.
Even if the economy recovers in the coming quarters, FY21 is likely to end in deep contraction. Several agencies, after a sharp contraction in India’s GDP growth in Q1FY21, have revised downwards the yearly GDP estimates to around -10% from about -5% projected earlier.
The Reserve Bank of India (RBI) as well, in the third bi-monthly Monetary Policy Statement, 2020-21 (dated August 6, 2020) anticipated real GDP growth to remain negative (in line with May resolution) in FY21 owing to the disruption caused by COVID-19.
Only an early containment of the COVID-19 pandemic may impart an upside to the outlook, observed the RBI.
A more protracted spread of the pandemic, deviations from the forecast of a normal monsoon, and global financial market volatility are the key downside risks, it stated.
Graph 1: India’s GDP growth plunged into negative territory due to the COVID-19 lockdown impact
Data as of June 2020 quarter for GDP at constant prices
India’s core sector growth is straying in the negative zone, consumption is muted (the focus currently is on bare essentials and not discretionary spends), inflation is rising, the government is borrowing more, and India’s sovereign credit rating is downgraded to Baa3- with a negative outlook (just a notch above the investment grade).
To address growth concerns (while ensuring that inflation remains within the target), the RBI has been cutting policy rates since February 2019 and maintained its ‘accommodative stance’ since June 2019. The repo rate now stands at a multi-year low of 4.00%.
Table 1: Series of policy rate cuts in 2019-20 to address growth concerns
|Month||Repo Policy Rate||Policy rate cut (Basis points)||Monetary Policy Stance|
|Mar-20 (an exceptional off cycle meeting)||4.40%||75||Accommodative|
|May-20 (an exceptional 2nd off cycle meeting)||4.00%||40||Accommodative|
Data as of August 6, 2020
With inflation print moving beyond the RBI’s comfort zone of 4.00% (with a margin of 2 percentage points on either side), over the last couple of months due to supply chain disruptions, the RBI maintained a status quo on the policy rates and maintained its ‘accommodative stance’.
And to ensure that liquidity remains comfortable, the RBI has taken a host of conventional and unconventional measures since February 2020. Cumulatively, these measures have assured liquidity of the order of Rs 9.57 trillion or 4.7% of GDP.
To sail through challenging times, the government too has been front-loading expenditure. But in turn, India’s fiscal deficit has overshot by 103% of the budgeted target (of Rs 7.96 trillion) in the first four months through the fiscal year through July 2020 touching Rs 8.21 trillion.
On the backdrop of the above, the benchmark G-sec yield has hardened. Currently, the difference between the 10-year G-Sec yield and repo rate is around 200 basis points (bps) compared to the long-term average of 80 bps. In general, risk-aversion seems to have set in, which is pushing yields upward.
Graph 2: The 10-year benchmark yield hardening…
Data as of September 8, 2020
(Source: investing.com, PersonalFN Research)
Where are inflation and interest rates headed?
In this regard, the view expressed by RBI Governor, Mr Shaktikanta Das, in the minutes of the last monetary policy is noteworthy:
“As I have been reiterating since October 2019, monetary policy is geared towards supporting the economic recovery process. Although there is headroom for further monetary policy action, at this juncture it is important to keep our arsenal dry and use it judiciously. I also feel that we should wait for some more time for the cumulative 250 basis points reduction in policy rate since February 2019 to seep into the financial system and further reduce interest rates and spreads. Given the uncertain inflation outlook, we have to remain watchful to see that the momentum in inflation does not get entrenched, which is also dependent on effective supply-side measures. As the economy continues to be in a fragile state, recovery in growth assumes primacy. It would be prudent at this stage to wait for a firmer assessment of the outlook for growth and inflation as the staggered opening of the economy progresses, supply bottlenecks ease and the price reporting pattern stabilises. Considering all these aspects, I vote for a pause on the policy rate at this moment while continuing with the accommodative stance” – RBI Governor, Mr Shaktikanta Das
The RBI would remain watchful of incoming data to see how the outlook unravels.
Given these uncertain circumstances, it is difficult to foretell where the interest rates are headed. But overall it appears that the present interest rate cycle has bottomed out.
Why consider investing in a Dynamic Bond Fund?
Regardless of the direction of interest rates in the coming months, dynamic bond funds are capable of taking advantage of a dynamic interest rate and invest accordingly to create an all-season portfolio.
According to the capital market regulator’s categorisation norms, dynamic bond funds are open-ended dynamic debt schemes that invest across duration––short-term, medium-term and long-term––depending on where interest rates are headed. Thus a Dynamic Bond Fund holds the flexibility to adjust the duration of the portfolio to benefit from the possible change in the interest rate scenario.
As you may be aware, bond prices and interest rate are inversely related. In a falling interest rate scenario, long-term instruments tend to perform well; while in the rising interest rate scenario, short-term instruments tend to perform better.
If interest rates are anticipated to escalate, dynamic bond funds allocate a higher portion of their portfolio in low duration bonds and re-invest the proceeds at a higher rate. Conversely, if interest rates are expected to fall, a Dynamic Bond Funds invest in long term bonds to benefit from the subsequent rally in bond prices. Therefore, a Dynamic Bond Fund could typically hold short-term instruments, such as commercial papers (CP) and certificates of deposit (CDs), and/or long-term instruments, such as corporate bonds and gilt securities, depending on the interest rate outlook.
Dynamic bond funds generally invest in fixed income instruments that have a residual maturity of 3 years and above.
Table 2: Report card of dynamic bond funds
Scheme Name ** Absolute (%)** ** CAGR (%)**
6 Months 1 Year 2 Years 3 Years 5 Years
Category average - Dynamic Bond Fund 4.02 8.60 9.82 6.97 8.35
Data as on September 07, 2020
(Source: ACE MF)
At a time when interest on Bank Fixed Deposits (FDs) and other Small Saving Schemes (SSS) have turned unappealing, a worthy Dynamic Bond Fund can help you earn better returns and provide better liquidity.
The investment objective of a Dynamic Bond Fund usually is to generate income and capital appreciation through active management of a portfolio consisting of short-term and long-term debt and money market instruments.
Here are five key benefits of investing in a Dynamic Bond Fund…
- Reduces interest rate risk through active management of portfolio based on interest rate outlook;
- No need to time the entry and exit in the debt market because fund managers take care of it;
- Offers a solution for your long term debt investment needs;
- Acts as a tax-efficient instrument in the form of indexation benefit on long term capital gain;
- Potential to earn better returns and have higher liquidity than Bank FDs with higher risk Compare to bank FDs.
That being said, do note that the performance of a Dynamic Bond Fund largely depends on the fund manager’s judgement of the interest rate movement. If the manager fails to accurately gauge the movement of interest rates or is unable to time the investment precisely, investors may suffer losses.
Additionally, the evolving crisis in the corporate bond segment has made debt funds with higher exposure to private issuers vulnerable to credit risk, and may not be considered a safe bet for conservative investors.
Therefore, it is important to invest in a dynamic bond fund with a well-diversified portfolio of securities, a dynamic maturity profile, and high-quality debt & money market instrument (predominantly government securities).
Who should invest in Dynamic Bond Fund?
A Dynamic Bond Fund is sensitive to interest rate changes and may, therefore, witness some volatility. Investors with an investment time horizon of at least 3 to 5 years and who do not mind exposure to some volatility, may consider a Dynamic Bond Fund.
Pay attention to the following parameters to pick the best Dynamic Bond Fund:
The portfolio characteristics of the debt schemes
The average maturity profile
The corpus & expense ratio of the scheme
The rolling returns
The risk ratios
The interest rate cycle
The investment processes & systems at the fund house
On the risk-return spectrum of debt funds, a dynamic bond is placed slightly on the higher-end – between medium duration debt and a long duration debt fund.
Do not assume investments in debt funds (including short-duration funds) to be safe or risk-free; there is an element of risk involved. Therefore, it is important to invest in debt schemes that align with your risk appetite, investment horizon, and investment objective.
Mutual fund investments are subject to market risks, read all scheme related documents carefully.
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Please visit – www.QuantumMF.com to read scheme specific risk factors. Investors in the Scheme(s) are not being offered a guaranteed or assured rate of return and there can be no assurance that the schemes objective will be achieved and the NAV of the scheme(s) may go up and down depending upon the factors and forces affecting securities market. Investment in mutual fund units involves investment risk such as trading volumes, settlement risk, liquidity risk, default risk including possible loss of capital. Past performance of the sponsor / AMC / Mutual Fund does not indicate the future performance of the Scheme(s). Statutory Details: Quantum Mutual Fund (the Fund) has been constituted as a Trust under the Indian Trusts Act, 1882. Sponsor: Quantum Advisors Private Limited. (liability of Sponsor limited to Rs. 1,00,000/-). Trustee: Quantum Trustee Company Private Limited. Investment Manager: Quantum Asset Management Company Private Limited. The Sponsor, Trustee and Investment Manager are incorporated under the Companies Act, 1956.
The data in this presentation are meant for general reading purpose only and are not meant to serve as a professional guide/investment advice for the readers. This presentation has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been suggested or offered based upon the information provided herein, due care has been taken to endeavour that the facts are accurate and reasonable as on date. Quantum AMC shall make modifications and alterations to the performance and related data from time to time as may be required as per SEBI Mutual Fund Regulations. Readers are advised to seek independent professional advice and arrive at an informed investment decision before making any investment. None of the Sponsors, the Investment Manager, the Trustee, their respective Directors, Employees, Affiliates or Representatives shall be liable for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including lost profits arising in any way from the data/information/opinions contained in this presentation. The Quantum AMC shall make modifications and alterations to the performance and related data from time to time as may be required as per SEBI Mutual Fund Regulations.