Should investors opt for debt mutual funds amid interest rate cut cycle? An explainer | Mint

The rate cut cycle kicked off in early 2025. In February this year, Reserve Bank of India’s (RBI) monetary policy committee (MPC) slashed the repo rate by 25 basis points to 6.25 percent after a gap of nearly five years.

In the two follow up policy meets, which took place in April and June, RBI cut the repo rate by another 75 basis points, thus reducing the interest rate by a total of 100 basis points. The current repo rate stands at 5.5 percent.

Is this good news for investors?

When RBI cuts the repo rate, bond yields start to fall, thus raising the prices of debt instruments. As a result, the net asset value (NAV) of debt mutual funds , which invest in these bonds, rises. This happens because the bond prices and yields tend to move in opposite directions. This means when interest rates fall, bond prices rise and vice versa.

Experts believe that the current interest rates are cheap (leading to higher NAV of long term debt funds) and worth buying while adding that there is a little possibility of further rate cut. However, RBI governor Sanjay Malhotra said in a recent media interview that the banking regulator may plan to cut interest rates further if growth comes under pressure.

“RBI reduced repo rate by 50 bps in June MPC meeting. While RBI did cut the rates, the stance of policy was changed from Accommodative to Neutral, signalling no further rate cuts in current cycle. Looking beyond near-term volatility, we believe interest rates are cheap and worth buying. We expect RBI to maintain surplus systemic liquidity, which means that operating rates will be lower than repo rate. Current yields are providing decent spread over operating rate. Also, yields at longer end of yield curve are much above long term averages, making them a potential buying opportunity for long term investors,” says Akhil Mittal, Senior Fund Manager-Fixed Income, Tata Asset Management.

Which debt funds should investors opt for?

There are around 16 categories of debt mutual funds, per the Sebi’s categorisation of mutual fund schemes. These include overnight funds, liquid funds, ultra short duration funds, low duration funds, money market funds, short duration funds, medium duration funds and long duration funds, among others.

Out of these categories, which debt funds are good for retail investors is a function of investors’ risk appetite and investment goal. If an investor, for instance, has a high-risk appetite and is willing to bear volatility, then he can opt for long term debt funds. Else, s/he can invest in the short-duration debt funds.

“Investors may look to invest in debt mutual funds keeping their investment period and appetite for near term volatility in mind. For long term investors, who may have some appetite for near term volatility, longer duration funds like Gilt Funds could make a good investment option. For investors who want lesser volatility and more predictability, 2 to 3 year duration debt funds could be a good option,” adds Mittal of Tata Mutual Fund.

“Investors looking to invest for a period greater than 6 months should look at high quality funds like short duration funds, corporate bond funds and Banking – PSU funds. Investors looking to invest for a period of less than 6 months, should consider Money Market funds,” says Jalpan Shah, Head Fixed Income, Trust Mutual Funds. 

Sridharan S, a Sebi-registered investment advisor and founder of Wealth Ladder Direct says, “Investors can invest in the long-term debt funds to make the most of falling interest rate cycle.”

Note: This story is for informational purposes only. Please speak to a SEBI-registered investment advisor before making any investment related decision.

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