Dynamic Funds: Your One-Stop Guide

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  • 27 Dec 2023
Dynamic Funds: Your One-Stop Guide

Key Highlights

  • Dynamic bond funds invest in debt securities with different maturity dates.
  • To reduce risk and obtain a better return, the Fund Manager will invest in different types of debt securities.
  • Dynamic bond funds differ from other debt funds in that the fund manager can move from a medium-term bond to a low-duration bond and vice versa.

Dynamic mutual funds are a type of open-ended debt mutual fund with flexibility on portfolio positioning according to the ever-changing market conditions. In other words, a dynamic fund is a mutual fund scheme in which the fund manager adjusts asset allocations based on the reading of market conditions and interest rate dynamics.

Dynamic bond funds have the potential to provide superior returns under different interest rate scenarios as fund managers can dynamically adjust their allocation of assets. However, they are also highly volatile compared to other short-term and medium-term debt funds. By minimising the losses incurred, dynamic mutual funds protect themselves from market downturns.

The Dynamic Debt Fund's fund manager invests in various securities with varying durations. After adjusting for his reading of interest rate markets, these allocations will then be recalculated. To minimise exposure to interest rate risks, in the event a fund manager believes that interest rates will increase in the future, they invest in shorter-term bonds. In the meantime, they intend to reinvest the maturity revenues at future interest rates.

If a fund manager expects interest rates to decline, they will also invest in bonds with longer maturities and thus reap the benefits of price appreciation. Therefore, as the market scenario changes, the dynamic fund manager will attempt to maximise returns by changing the duration of the dynamic fund.

The asset allocation of a dynamic debt fund is decided by fund management based on projected interest rates. The primary securities in which these dynamic funds invest are listed below, with varied maturity dates:

  • Debt instruments and government securities
  • Bonds that banks issue
  • Corporate Bonds: Securities That Are Not Convertible
  • PSU bonds

Dynamic bonds are an appropriate investment for investors looking for the best yields in a changing interest market environment. These investors should also enjoy a moderate risk appetite. For at least 3 to 5 years, active investors must keep their investments in Dynamic Mutual Funds. For this reason, investors can experience multiple interest rate cycles during sufficiently long investment periods to achieve better returns on their investments.

It is also beneficial to remain invested longer because investors can pay long-term capital gains tax on such returns. Investors wishing to invest in dynamic funds should select the SIP route.

Several advantages arise from the flexibility given to dynamic debt funds when they invest in various types of bonds with different maturities. These are the following.

  1. Dynamic funds, subject to SEBI's mandatory duration mandates, may deliver higher returns than short-term mutual funds. This is because they invest in long-duration bonds that generate higher yields and price appreciation.

  2. Dynamic funds are used to hedge against constant changes in interest rates and thus deliver the best possible returns.

  3. Compared to long-duration funds that cannot reduce their fund duration below the SEBI Guidelines, dynamic funds can better cope with the risk of loss. Consequently, dynamic funds are less volatile if interest rate scenarios change more than expected.

Unlike other debt mutual fund schemes, dynamic funds are subject to the same taxation implications. Therefore, an STCG tax is payable on investments held for less than three years, while an LTCG of 20% applies to dynamic funds with more than three years' duration in which indexation has been allowed. Given the applicable income tax rate, the dividends received will be taxed.

The risks associated with such Mutual Funds are given in the following order:

  1. The fund manager may adjust the asset allocation depending on the prevailing market and economics. These changes may only please investors in the short run. Liquidity and credit risks are associated with debt assets of dynamic bond funds.

  2. In cases where issuers of securities cannot meet their obligations about interest payments and repayments, credit risk may arise. This covers a part of the portfolio dedicated to non government security.

  3. Liquidity issues may prevent fund managers from being able to sell underlying assets.


The information on Dynamic Bond Funds, their benefits, associated risks, and suitability are set out in this blog. Such debt funds aim to adapt their asset allocation to take advantage of prevailing interest rates. The skill of the Fund Manager in question, therefore, plays a significant role in their returns.

FAQs on Dynamic Fund

Dynamic Bond Funds are designed to allow for the diversification of debt instruments across different tenures. You can swiftly move between long-term, short-term, and mid-term securities. The shift is dependent on the cycles of interest rates.

Dynamic bond funds are an excellent choice for debt investors who seek more active investment options. These funds have both short and long-term debt securities in their portfolios, although returns may be more erratic for shorter periods. But in the falling interest rate environment, they tend to do well.

Debt schemes in which the fund manager is free to decide how long a portfolio can be established are referred to as dynamic bond funds. So, a fund manager considers that interest rates are likely to rise. In that case, it can increase exposure to shorter-maturity bonds because they are less sensitive to changes in interest rates.

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