Navigating Rising Bond Yields: Strategic Repositioning for Debt Fund Investors
Bond yields have hardened significantly following the Reserve Bank of India's (RBI) decision to maintain policy rates unchanged and refrain from announcing fresh liquidity measures in its latest monetary policy meeting. This development has created important implications for debt fund investors who must now carefully reposition their portfolios to guard against further upside risks.
Understanding the Yield Movement
The yield on 10-year government securities has risen by 10 basis points over the past month, raising concerns among bond investors. Higher yields typically translate into lower bond prices, creating challenges for fixed-income portfolios. Market participants had been expecting the central bank to provide liquidity support after the Union Budget 2026–27 unveiled record government borrowing of ₹17.2 trillion to fund spending initiatives.
Higher borrowing usually leads to an increased supply of government securities, which naturally pushes yields higher through basic supply-demand dynamics. With expectations of another RBI rate cut in the current calendar year largely fading, investors face a changed landscape that requires strategic adjustments.
Expert Recommendations for Portfolio Positioning
Most financial experts are advising investors to focus on short-duration, accrual-oriented strategies where returns are driven primarily by interest income rather than capital gains. This approach minimizes exposure to yield volatility while providing steady returns.
"Our core recommendation is to invest in the liquid-plus segment, which includes funds up to two years' duration," said Manish Banthia, Chief Investment Officer for Fixed Income at ICICI Prudential Asset Management Company. "This includes floating-rate funds, low-duration funds and money market funds."
Liquidity tightness has pushed up spreads on one-year commercial papers (CPs) and bank certificate of deposits (CDs) as well as two-year corporate bonds, making this segment particularly attractive from a risk-reward perspective according to Banthia.
Corporate Bond Funds as a Viable Option
Corporate bond funds represent another category where fund managers suggest investors can park their money effectively. Dhawal Dalal, President and Chief Investment Officer for Fixed Income at Edelweiss Mutual Fund, explained: "Quality 9- to 12-month CP-CD are yielding 7%-plus and double A-rated CP-CD are yielding 8% plus now. Given that overnight rates are going to be closer to 4.5-5% in the near-term and RBI is unlikely to raise the repo rate in CY26, these assets offer decent yield pick-up."
Puneet Pal, Head of Fixed Income at PGIM India Mutual Fund, echoes this perspective: "We have been advocating short-duration strategies, up to three years, with a focus on accrual. From a relative risk-reward perspective, the one-year segment looks better."
Deepak Agrawal, Chief Investment Officer for Debt and Head of Products at Kotak Mahindra AMC, added: "Given that easy liquidity conditions are expected to prevail, we believe this segment — the short end of the bond yield curve — can decline further by another 20–30 basis points. This is a relatively insulated segment where investors may see capital gains over the next 12–18 months."
Investors may consider categories like corporate bond funds and banking & PSU debt funds, which typically feature 100% AAA‑rated portfolios with yields close to 7.25–7.30%. With easing currency pressures and expectations of continued easy liquidity, these products can potentially offer about 100 basis points more than traditional fixed‑income options.
Tactical Opportunities in Longer-Duration Strategies
The recent spike in yields has also opened up tactical opportunities in longer-duration strategies, though these should be approached as short-term investment opportunities rather than core holdings.
Banthia of ICICI Prudential AMC believes the sharp rise in government bond yields has created a tactical entry point in gilt (government securities) funds. These funds invest in a mix of government securities and SDLs (state development loans), which are bonds issued by state governments that typically offer slightly higher yields than central government securities.
"Long-duration government securities and SDLs now look attractive from a valuation perspective, as market sentiment has turned very pessimistic," Banthia noted. "Much of the concern around high borrowing and supply pressures is already reflected in current yields."
Sahil Kapoor, Head of Products and Market Strategist at DSP Mutual Fund, added: "With bond supply under control, inflation behaving well, liquidity stable, and long-term yields offering decent compensation, current yield on the 10-year G-sec looks like a sensible entry point for investors willing to extend duration."
Key Takeaways for Investors
The rise in bond yields presents both challenges and opportunities for debt fund investors. With expectations of further rate cuts largely priced out, bond yields are now likely to be driven more by demand-supply dynamics in the debt market rather than monetary policy expectations.
Fund managers recommend that investors should:
- Anchor the core of their debt portfolios in shorter-duration funds
- Consider corporate bond funds and banking & PSU debt funds for their AAA-rated portfolios and attractive yields
- View longer-duration strategies as tactical plays rather than core holdings
Those with higher risk appetite may consider allocating 10–20% of their debt portfolio to long-duration strategies as a tactical play, understanding that longer-duration papers carry higher volatility due to their greater sensitivity to yield movements.
Joydeep Sen, a corporate trainer in financial markets and author, cautioned: "The tactical play is only suited for more savvy investors who understand the dynamics of debt markets and have the ability to enter and exit such strategies at the right time. Regular investors should stick to the shorter duration strategies."
As the bond market continues to evolve, maintaining a balanced approach that combines stability through short-duration funds with selective tactical opportunities in longer-duration instruments appears to be the most prudent strategy for navigating the current yield environment.
