As the Reserve Bank of India has kept the repo rate unchanged, investors should consider short duration bond funds now. These benefit from stable yields and focus on earning interest income.
Top-performing short duration bond funds such as Axis and Nippon India’s have given returns of around 10% in the last six months and around 9% in the last one year.
The yield curve has flattened, and short-to-medium-term bonds, with maturity of one to three years, are offering attractive carry without taking on excessive duration risk. Given the limited scope for further rate cuts, long-duration bonds have become less attractive now.
A core allocation of around 70% to accrual-focused short-tenure instruments can help generate stable interest income with lower volatility, while a satellite allocation of around 30% to long-duration assets can provide potential for capital appreciation if yields decline further. “This barbell approach allows investors to earn steady returns through accrual while maintaining some upside from rate movements, without taking excessive duration risk,” says Nirav Karkera, head, Research, Fisdom.
Type of funds
For short-duration strategies, money market and corporate bond funds can be ideal options. These funds offer a good balance of yield and stability, with relatively lower sensitivity to interest rate movements. “Investors should consider low-duration funds (maturity of one-to-three years) or money market funds (up to one year) for modest returns,” says Soumya Sarkar, co-founder, Wealth Redefine, an AMFI registered mutual fund distributor.
For investors seeking yield and near-term capital appreciation, dynamic bond funds or corporate bond funds offer a balanced risk-reward profile.
Time to book profits in long-duration bonds
Over the past 12 to 15 months, India’s fixed income market has delivered stellar returns, particularly in long-duration government securities. A research note by Axis Asset Investment says investors have benefitted from capital appreciation as yields have fallen and spreads on 10-year and 30-year bonds compressed sharply. “This rally was driven by a confluence of macroeconomic easing, fiscal discipline, and tactical demand-supply dynamics,” it says.
The structural rally in long-duration bonds appears to have largely played out—at least in the near term—given the sharp fall in yields over the past year and the aggressive rate cuts already delivered by the central bank.
Much of the expected easing is now priced in, limiting further upside potential from a duration strategy. A staggered exit or rebalancing into medium-duration funds could offer a balanced approach—capturing some upside while reducing volatility.
“Investors sitting on gains from long-duration or gilt funds could consider booking partial profits and rotating to shorter-duration strategies,” says Sonam Srivastava, founder, Wright Research PMS. Those with a higher risk appetite or strong conviction in further easing of rates may choose to retain a smaller allocation to duration.
What to consider
Before investing, investors should align the fund’s duration with their own investment horizon—this helps optimise returns and reduces the impact of interim market volatility. Investors must assess the credit quality of the underlying portfolio, the fund’s historical volatility, and the consistency of the fund manager’s strategy.
“Investor need to select short-term debt funds with AAA-rated portfolios to reduce credit or default risk,” says Swapnil Aggarwal, director, VSRK Capital. They must go for funds that prioritise sovereign paper, have low modified duration and have a proven track record of managing liquidity. Roll-down strategies should be preferred.
Matching investment duration with fund duration is important for maximising accrual and minimising reinvestment and interest rate risk. Investors should evaluate the fund manager’s ability to manage reinvestment risk and monitor for concentration in single issuers.