Don’t put all eggs in long duration basket! Experts say short-term funds can offer stable returns at lower risk - explained

Bond investors who had pinned hopes on aggressive rate cuts this year have learnt a hard lesson. Despite big rate cuts, which should have pushed up bond prices, bonds have faced selling pressure.

Softening inflation and India’s entry into global bond indices had led to all round optimism. But the RBI’s cautious stance in June spooked the market, dampening hopes of further easing.Rising bond yields caught fund managers off guard. Most debt fund categories have churned out dismal returns in the past three months. Long duration funds are the worst performers with average 3-month returns in negative territory (see table).

Even dynamic bond funds, which actively manage the interest rate risk by shifting between instruments of different maturities, have done poorly.

How debt fund categories have fared

Data as on 12 Sep 2025Source: Value ResearchExperts say bond investors need to be cautious because chances of a rate cut have dwindled, while inflation may see a comeback due to erratic rains in the past 1-2 months. “Further downside on interest rates looks unlikely so bond yields are likely to remain rangebound,” says Nachiket Naik, Head of Structured Credit at Axis Mutual Fund.

“Incremental returns from bond funds may not be as attractive as before,” agrees Sandip Raichura, CEO of Retail Business at PL Capital.For investors, this means limited upside from long duration bonds even as the accrual strategy makes a comeback. With elevated short-term yields, investors can lock into attractive accrual income without taking on significant duration risk. Even if rate cuts are pushed further down the calendar, these funds continue to generate steady returns.

At the same time, maintaining some exposure to medium- or long-duration funds ensures investors don’t miss out if yields finally soften.Raichura suggests a barbell approach that allocates across both short-term and long-term debt funds, thereby creating balance. “Investors should allocate 30% of their fixed income portfolio to short-term bond funds, including dynamic funds, about 40% to gilt funds, and 30% to corporate bond funds. One-third of that, or roughly 10% of the portfolio, could be in credit risk,” he says. Such diversification can provide stability as well as participation in any eventual rate-driven gains.(Disclaimer: Recommendations and views on the stock market and other asset classes given by experts are their own. These opinions do not represent the views of The Times of India)