Some debt funds tend to follow a pre-defined investing strategy in order to maximise their earnings, and also to keep volatility under control. One of such strategies is a roll-down strategy that is followed by debt mutual funds. This is essentially followed to curb the risk of interest rate fluctuation on debt funds.
Let us explain in detail what does it mean and how it curbs the risk of volatility.
Roll down strategy
It is a strategy to offer returns with less volatility to investors. In this, fund manager buys bonds closer to maturity date and hold them till maturity.
As the bond approaches maturity, the fund manager gradually sells them and buys shorter-term bonds with lower yields.
As a result, fund’s maturity period keeps ‘rolling down’. Since the duration of the bond reduces over time, the interest rate risk also reduces. Consequently, it ensures more predictable returns for investors.
In other words, it is a trading strategy for selling bonds towards the close of maturity date. For the unversed, a bond’s yield falls as the maturity date comes closer while its price rises.
This strategy is usually followed when fixed income returns start falling, and mutual funds try to woo investors through this strategy. It is based on the premise that a bond's value moves closer to par in run up to its maturity date.
Predictable returns
It is suggested for investors to join debt funds with a roll-down strategy if they are looking forward to predictable returns over a period of time, and also if their financial goals coincide with the fund's target period.
Some of the mutual funds that follow roll down strategy include Nippon India Dynamic Bond Fund, Axis Dynamic Bond and L&T Triple Ace.
Benefits
There are a few benefits of this strategy. One of the key benefits is that the investor can lock in a high yield by buying a long-term bond. Investors stands to benefit from rising interest rates by reinvesting in shorter-term bonds while the original bond approaches maturity.
Besides this, one can avoid the risk of holding a long-term bond during falling interest rate scenario, as they would be able to sell the bond and reinvest at a higher rate.
And just as other debt funds, these funds entitle investors to make the most of indexation benefits and long-term capital gains tax provided these funds are held for a minimum period of 36 months.
Risk involved
It's worth noting that the roll down strategy is somewhat complex and still involves a degree of risk as it hinges on predicting interest rate movements and requires careful monitoring and management of the investor’s portfolio.
