Is This the Right Time to Invest in Medium and Long-Term Debt Mutual Funds?

Apr 24, 2023 / Reading Time: Approx. 6 mins

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Medium and long-term debt mutual funds generated muted returns in FY 2022-23 as the RBI undertook multiple rate hike actions during this period to tame inflation and support economic growth. Meanwhile, short term debt mutual funds such as Liquid Funds and Ultra Short Duration Funds fared better. This is because when interest rates rise, the prices of bonds fall. The impact is higher on medium and long-term debt mutual funds as they are more sensitive to movement in interest rates.

However, things have started to look up for medium and long term debt mutual funds. As you may be aware, the Reserve Bank of India (RBI) kept the repo rate unchanged at 6.5% during the April 2023 monetary policy meeting. The RBI observed that the prospects of a record rabi harvest bodes well for easing of food price pressures. Global commodity prices have also moderated significantly from their heightened levels a year ago.


Given that CPI inflation has cooled off from its peak and the fact that RBI has increased the policy repo rate (by 250 basis points) successively since May 2022, it appears we have almost peaked out on the interest rate cycle.

To be sure, the RBI has stated that the April policy decision is a pause and should not be seen as a pivot. This means that the RBI may once again hike interest rates if global inflation remains stubbornly elevated due to factors such as global uncertainties, unseasonal rains, and adverse climatic conditions.

However, the rise in bond yields is expected to be limited going forward as the debt market has already priced in aggressive rate hikes. There is a consensus that RBI might hit the pause button before taking any decision to cut the policy rates. Bond yields are expected to remain range-bound and may start declining gradually. This makes it an opportune time to gradually get into medium and long-term debt mutual funds.

Bond yield softened after RBI kept policy rate unchanged

Data as of April 21, 2023
(Source:, PersonalFN Research)

When interest rates fall, medium to long duration instruments witness higher fall in prices compared to short duration instruments. Accordingly, debt mutual funds that invest in these bonds benefit as their NAVs witness higher appreciation.

Furthermore, the expectation of the equity market facing pressure due to global uncertainty and lack of positive triggers also makes a case for investing in debt mutual funds for diversification.

What should be your investment strategy when investing in medium to long-term debt mutual funds?

The bond market can witness volatility in the near term till there is clarity on the end of the rate hike cycle. Therefore, when you invest in medium and long-term debt mutual funds, prefer to do so in a staggered manner to mitigate interest rate risk.

You can consider investing in a mix of safely managed Dynamic Bond Funds, Banking & PSU Debt Funds, Corporate Bond Funds, and Gilt Funds. The quantum of exposure and type of schemes to invest in will depend on your investment objectives, risk appetite, and investment horizon. If you have a short-term goal to achieve, you would be better off investing in short-term debt mutual funds such as Liquid Funds.

[Read: 5 Best Debt Mutual Funds to Invest in 2023]

[Read: 5 Best Low-Risk Mutual Funds to Invest in 2023]

Is This the Right Time to Invest in Medium and Long-Term Debt Mutual Funds?
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Prefer debt mutual fund schemes that invest predominantly in government and quasi-government securities and high-quality corporate debt instruments to mitigate credit risk.

Always remember, when you invest in debt funds, your primary aim should be the preservation of capital; returns come secondary. To select the best debt mutual fund, it is important to assess the following parameters:

  • The credit quality of the underlying securities

  • The average maturity profile

  • The historical performance

  • The risk ratios

  • The investment processes & systems at the fund house

Lastly, remember that though debt mutual funds are relatively stable compared to equity mutual funds, the returns are not guaranteed. However, if you choose schemes carefully, they can offer you opportunities for effective diversification and asset allocation.

Does it make sense to invest in debt mutual funds after the change in tax rules?

The Finance Bill 2023 amended the debt mutual fund taxation rule by removing the indexation benefit in case of long term capital gains on these funds. This rule applies to all mutual fund schemes, including Gold Funds and International Funds, that invest less than 35% of their assets in domestic equities. As a result, debt mutual funds are now on par with Bank FDs for taxation. The change in tax rule has made debt mutual funds less attractive for investors under the highest tax slab.


Does this mean investors should prefer Bank FDs over debt mutual funds?

Debt mutual funds can potentially generate higher returns compared to other low-risk avenues, such as Bank FDs, especially during stable and falling interest rate scenarios. Therefore, if you are willing to take a slightly higher risk for a better return, debt mutual fund may be preferable over Bank FDs. Investors in debt mutual funds have the option to select from a variety of offerings across liquidity, maturity, and credit quality, as well as active and passive strategies. Debt mutual funds also have the flexibility to tweak their portfolio in line with the changing market conditions, within their investment mandate. This enables you to create a personalised portfolio that aligns with your financial needs.

[Read: Should You Consider Arbitrage Funds After Change in Debt Mutual Fund Taxation]

Moreover, most debt mutual funds do not carry any exit load after completing a short holding period, whereas you will be charged a penalty if you withdraw your FD before maturity. That said, if you are averse to risk and are looking to earn fixed returns, consider Bank FDs.

DIVYA GROVER is the co-editor for FundSelect, the flagship research service of PersonalFN. She is also the co-editor of DebtSelect. Divya is an avid reader which helps her in analysing industry trends and producing insightful articles for PersonalFN’s popular newsletter – Daily Wealth letter, read by over 1.5 lakh subscribers.

Divya joined PersonalFN in 2019 and has since then used stringent quantitative and qualitative parameters to analyse funds to provide honest and unbiased research to investors. She endeavours to enable investors to make an informed investment decision and thereby safeguard their wealth.

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.

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