- Rising bond yields may reduce returns from gilt and long-duration debt funds
- 10-year government security yield has increased by 42 basis points this year
- Rate hikes by RBI could occur as early as June 2026, affecting bond yields
Rising government bond yields and the possibility of higher interest rates could weigh on returns from gilt funds and other long-duration debt schemes, prompting investors to reassess their debt mutual fund portfolios.
The yield on the benchmark 10-year government security has risen about 42 basis points so far this year and is hovering around 7%. Higher crude oil prices, foreign portfolio investor outflows, rupee weakness, fiscal concerns and inflation risks have all contributed to the move. Uncertainty around the interest-rate outlook has also kept investors cautious, with many demanding higher returns to hold government bonds.
The shift matters because bond yields and bond prices move in opposite directions. When yields rise, newly issued bonds offer higher interest rates, making existing bonds with lower coupon rates less attractive. As a result, the prices of existing bonds fall, which can reduce the net asset value of debt funds holding those securities.
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Yield Pressure
The Reserve Bank of India has kept the repo rate unchanged at 5.25% this year after cutting rates by a cumulative 125 basis points in 2025. While the easing cycle supported debt markets earlier, concerns about inflation have raised questions over whether the rate-cut cycle has ended.
Market participants are increasingly assessing the possibility of a rate hike later this year. Some analysts believe the RBI could raise rates by around 25 basis points in a calibrated manner, potentially as early as June 2026, if inflationary pressures persist.
Higher policy rates generally support higher bond yields because investors demand greater returns from fixed-income securities. The prospect of tighter monetary policy has therefore added to pressure on government bond prices and contributed to elevated yields.
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Portfolio Shift
Against this backdrop, investors may want to keep their debt fund portfolios' sensitivity to interest-rate movements low. Long-duration funds, including gilt funds, are typically more vulnerable to rising yields because even small changes in interest rates can have a larger impact on the value of longer-maturity bonds.
If yields continue to rise, these schemes could face mark-to-market losses, limiting their short-term return potential.
Investors seeking to reduce interest-rate risk may consider debt funds focused on accrual strategies instead. Ultra-short duration funds may suit investors with a three- to six-month investment horizon, while money market funds may be appropriate for periods of six months to one year.
Corporate bond funds and banking and PSU debt funds may be suitable for investors with a one- to three-year horizon. For very short-term liquidity requirements, liquid funds with no exposure to private issuers may also be considered.
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Safety First
Investors may also want to avoid debt funds with high credit risk, where fund managers seek higher yields by investing in lower-rated securities.
Those unwilling to take market-linked risk may consider bank fixed deposits instead. A laddering strategy, which spreads investments across multiple maturities such as six months, one year, two years and three years, can help balance liquidity needs and return expectations while reducing reinvestment risk.
The broader message for investors is to align debt allocations with the interest-rate outlook, risk profile, investment objectives and time horizon.
While generating returns remains important, preserving capital and maintaining liquidity may deserve equal attention in the current environment, particularly when rising yields and policy uncertainty continue to shape debt market performance.
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Disclaimer: The views expressed in this article are solely those of the author and do not necessarily reflect the opinion of NDTV Profit or its affiliates. Readers are advised to conduct their own research or consult a qualified professional before making any investment or business decisions. NDTV Profit does not guarantee the accuracy, completeness, or reliability of the information presented in this article.
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