Rising government bond yields and the possibility of higher interest rates could weigh on returns from gilt funds and other long-duration debt schemes.
With the 10-year government security yield hovering around 7% after rising 42 basis points so far this year, investors may need to reassess their debt mutual fund portfolios. Higher crude oil prices, foreign portfolio investor outflows, rupee weakness, fiscal concerns and inflation risks have contributed to the rise in yields.
The shift matters because bond yields and bond prices move in opposite directions. If yields continue to rise, the value of existing bonds may fall, putting pressure on the net asset value of debt funds that hold longer-duration securities.
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Yield Pressure
The Reserve Bank of India has kept the repo rate unchanged at 5.25% in April after cutting rates by 125 basis points in 2025. However, concerns about inflation have raised the possibility that the rate-cut cycle may be over.
There is a chance that the central bank could raise rates later this year, potentially as early as June 2026, by around 25 basis points. Higher interest rates typically support higher bond yields because newly issued bonds offer better coupon rates than existing securities.
As a result, investors may continue to demand higher returns from government bonds, keeping yields elevated.
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Portfolio Shift
Against this backdrop, medium- and long-duration debt funds, including gilt funds, may face pressure. Rising yields can lead to mark-to-market losses in these schemes, reducing their short-term return potential.
Investors looking to keep interest-rate risk low may consider debt funds focused on accrual strategies instead.
Ultra-short duration funds may suit investors with a three- to six-month horizon. Money market funds may be suitable for investment periods of six months to one year. Corporate bond funds and banking and PSU debt funds may fit investment horizons of one to three years.
For investors with very short-term liquidity needs, liquid funds with no exposure to private issuers may offer an alternative.
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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. A laddering strategy, which spreads investments across different maturity periods such as six months, one year, two years and three years, can help balance liquidity and returns.
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.
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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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