Fund call. UTI Dynamic Bond Fund: Steady performer across rate cycles

After the splendid run in 2016, it’s time for debt investors to temper their expectations this year. The yield on government bonds, after falling by a steep 1.5 percentage points last year, has limited scope to head south.

After lowering repo rate by 175 basis points from the beginning of 2015, the RBI is likely to reduce rates by another 25-50 basis points this year, at best. Global uncertainties, mostly from US Fed rate hikes, can cause gyrations in the domestic bond market as well.

If you are a conservative debt investor, unwilling to bet on interest rate movements, then dynamic funds fit the bill in a volatile market.

With the flexibility to juggle between short-term and long-term debt instruments, these funds can contain downside better in an iffy market.

Since the fund manager’s call is important in these funds, it is best to bet on consistent performers over the long run.

UTI Dynamic Bond Fund has been a steady performer, delivering 11 per cent annualised return over the last five years, across various rate cycles — both up and down. The fund has also been a top quartile fund within its category over a three and five-year period.

Over the past year, it has delivered a healthy 15.5 per cent return, making the best of the sudden bond rally during 2016.

Interest rate movements in the economy impact bond prices. If the interest rates move up, bond prices fall and vice versa.

As longer duration bonds are more sensitive to interest rates, the fund manager increases duration to cash in on the rally in bonds in a falling rate scenario. In a rising rate environment, the fund manager reduces the duration of the fund to cap losses.

UTI Dynamic Bond Fund has actively managed its duration to respond to rate movements. In 2016, for instance, the fund increased the average maturity from 5-6 years in February-March, all the way to 11-12 years by the end of the year to cash in on the bond rally.

In the past too, the fund has been taking active calls on rate movements.

Between April 2012 and May 2013, it clocked a healthy 13 per cent return, by increasing maturity from 3-4 years in the beginning of 2012 to 9-10 years by the end of the year.

But it was quick to cut it back to just 1.8 years in July 2013, when the RBI’s liquidity tightening measures led to a spike in interest rates.

In the go-go year of 2014, when bonds rallied, the fund intermittently increased its maturity to rake in a healthy 15-odd per cent return.

In 2015, however, it kept its maturity high at 10-14 years which led to modest returns. However, it managed gains of 6.9 per cent, a tad higher than the category.

After keeping the maturity high through most of 2016, the fund manager has sharply reduced it to about 4.7 years as of December 2016, indicating the cautious stance on rate cuts. This should help cap downside in a volatile market.

Over the past two years, the fund has been holding a chunk — 75-90 per cent of portfolio — in safe government bonds. Currently it holds 48 per cent in G-Secs, 13 per cent in AAA rated bonds, and a high 31 per cent in cash.

While the fund’s exposure in recent years has mainly been in government bonds, in the past, like in 2013, it had a higher 20-30 per cent of its portfolio in AA rated bonds.

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