Bond yields have hardened after the Reserve Bank of India (RBI) left policy rates unchanged and refrained from announcing fresh liquidity measures in its latest monetary policy meeting.
Market participants had been expecting the central bank to step in with liquidity support after the Union Budget 2026–27 unveiled record borrowing of ₹17.2 trillion to fund government spending.
Higher borrowing usually leads to an increased supply of government securities, leading to higher yields with basic supply-demand dynamics at play.
With yields firming up, fund managers say debt fund investors need to strike a careful balance in their portfolios to guard against further upside risks. Here’s how they are positioning debt strategies in the current environment.
Caution on duration
Most experts are advising investors to stay in short-duration, accrual-oriented strategies, where returns are driven primarily by interest income rather than capital gains. This is also because expectations of another RBI rate cut in the current calendar year have largely faded for now.
“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 — fixed income, ICICI Prudential Asset Management Company. “This includes floating-rate funds, low-duration funds and money market funds,” he added.
Liquidity tightness has pushed up spreads on one-year commercial papers (CPs) and bank certificate of deposits (CDs) and two-year corporate bonds, making this segment attractive from a risk-reward perspective, Banthia said.
Liquid-plus funds typically include debt categories such as money market funds, low-duration funds, and ultra-short funds. Certain fund houses may also run short-duration strategies in floating-rate funds.
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“Quality 9- to 12-month CP-CD are yielding 7%-plus and double A-rated CP-CD are yielding 8% plus now. Given the fact 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, in our view” said Dhawal Dalal, President and Chief Investment Officer, – Fixed Income, Edelweiss Mutual Fund.
Puneet Pal, head of fixed income at PGIM India Mutual Fund echoes a similar view. “We have been advocating short-duration strategies, up to three years, with a focus on accrual,” he says. “From a relative risk-reward perspective, the one-year segment looks better.”
Corporate bond funds
Corporate bond funds are another category where fund managers say investors can park their money.
“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,” said Deepak Agrawal, chief investment officer, debt and head of products, Kotak Mahindra AMC.
“This is a relatively insulated segment where investors may see capital gains over the next 12–18 months. Either way, investors can benefit from superior carry compared to overnight or traditional fixed‑income products,” Agrawal explained.
Carry refers to the return an investor earns simply by holding a debt fund up to the portfolio’s target duration. At any point in time, a debt fund holds bonds that match its stated duration.
Investors may consider categories like corporate bond funds and banking & PSU debt funds, which are 100% AAA‑rated portfolios with yields close to 7.25–7.30%, Agrawal said. “With the trade deal in place, easing currency pressures, expectations of continued easy liquidity, and no rate hikes anticipated over the next 15–18 months, these products can potentially offer about 100 basis points more than traditional fixed‑income options.”
“Lower-duration funds, such as dynamic bond funds, that focus on corporate bonds and state development loans with one to three-year maturities can be considered,” said Mayur Chauhan, fund manager – fixed income, Quantum Mutual Fund.
“An accrual strategy—earning steady interest income from holding bond (spread assets) rather than trading—looks attractive. We expect interest rates to remain steady next year, with no chance of rate cuts,” he added.
Tactical play
Fund managers say the recent spike in yields has also opened up tactical opportunities in longer-duration strategies, but only as a short-term investment opportunity.
Banthia of ICICI Prudential AMC believes the sharp rise in government bond yields has created a tactical entry point in gilt (government securities) funds.
Gilt funds invest in a mix of government securities and SDLs. SDLs, or state development loans, are bonds issued by state governments to raise funds, typically offering slightly higher yields than central government securities.
The spreads on SDLS have expanded as there have been higher borrowings from state governments than what the market was expecting. These spreads (over the G-sec yields) may normalize,” said Joydeep Sen, a corporate trainer (financial markets) and author.
According to Banthia, long-duration government securities and SDLs now look attractive from a valuation perspective, as market sentiment has turned very pessimistic. Much of the concern around high borrowing and supply pressures is already reflected in current yields, he said.
He added that the market may be concerned about increased Centre and state borrowings. “The demand-supply dynamics in the bond market are never static. When yields are low, investors tend to stay away, but when yields rise to attractive levels, buying interest usually returns. At current levels, he believes yields are high enough to draw fresh demand.”
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.
“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,” said Sahil Kapoor, head of products and market strategist, DSP Mutual Fund.
After the RBI’s open market operations, banks are holding relatively lower levels of high-quality liquid assets. “As deposit growth picks up, banks will need to rebuild their statutory liquidity ratio (SLR) portfolios, which could lead to steady buying of government securities,” Banthia said. However, this should be considered as a short-term tactical play.
Takeaways
The rise in bond yields is often a source of concern in debt markets. Investors typically allocate to debt funds to add stability to their portfolios while earning steady, modest returns.
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. The benchmark 10-year G-sec yield could rise further if strong supply is not met by equally strong demand, or stabilise if demand remains adequate.
In the current environment, fund managers say investors should anchor the core of their debt portfolios in shorter-duration funds. Those with a higher risk appetite may consider allocating 10–20% of their debt portfolio to long-duration strategies as a tactical play.
Longer-duration papers, being more sensitive to yield movements, carry higher volatility and should therefore be treated as tactical allocations rather than core holdings.
“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,” Sen said.
