Can conservative investors still earn real returns in a falling rate cycle?
With interest rates falling and debt returns shrinking post tax, equity savings funds offer conservative investors a tax-efficient middle ground—if chosen carefully and held long enough.
To understand the challenge facing conservative investors today, it helps to begin with the interest rate cycle. The Reserve Bank of India (RBI) is currently in an easing phase, aimed at supporting economic growth.
In 2025, the RBI cut the repo rate by a cumulative 125 basis points, bringing it down from 6.50% to 5.25%. This has pushed down AAA corporate bond yields to maturity (YTM) from around 8% to the 6–7% range.
With consumer price inflation (CPI) at a low 0.71%, further rate cuts in 2026 remain possible—potentially compressing yields even further and leaving conservative investors with limited options to earn meaningful returns.
Inflation reality
India’s investor base remains far more skewed toward debt and fixed income than equities. Many conservative investors depend almost entirely on interest income.
While headline inflation is currently low—largely due to softer prices for vegetables, pulses and spices—miscellaneous goods and services inflation remains elevated at 5–6%.
As India develops, structural forces are likely to push interest rates lower over time. With indexation benefits no longer available for pure debt products, achieving attractive post-tax returns from traditional fixed income is becoming increasingly difficult.
A middle path
In this environment, one of the more efficient ways for conservative investors to improve post-tax returns—without taking full equity risk—is through selective hybrid products with limited equity exposure.
Equity savings funds, a category within hybrid mutual funds, invest across pure equity, arbitrage strategies and debt instruments. This structure allows them to generate more tax-efficient returns than pure debt products.
Unlike debt funds, which are taxed at slab rates, equity savings funds enjoy equity taxation: short-term capital gains (within 12 months) are taxed at 20%, while long-term capital gains (after 12 months) are taxed at 12.5%.
Know the risks
An important point conservative investors should understand is that equity savings funds come with very different risk profiles. Asset allocation across pure equity, arbitrage and debt varies widely from fund to fund. Some schemes are aggressive and volatile, while others are designed to be relatively stable.
Conservative investors therefore need to be selective and focus on funds that prioritise stability over returns. The most effective way to limit volatility is to choose schemes with clean arbitrage strategies, high credit-quality debt portfolios and, most importantly, a capped exposure of about 15–25% to pure equity.
What the data shows
To assess performance, 16 of the 25 equity savings funds were analysed using 3-year CAGR daily rolling returns from 1 January 2020 to 15 December 2025—a period that includes both severe market stress and strong recoveries.
Over this period:
Minimum returns ranged from -8.4% to 4.1% CAGR (mean: -0.5%),
Maximum returns ranged from 12.4% to 17.8% CAGR (mean: 14.1%), and
Average returns ranged from 3.3% to 10.5% CAGR (mean: 8.5%).
The most consistent performer—despite having a relatively higher equity allocation of about 25%—managed to generate at least 8% CAGR returns for 84% of the period analysed.
The data clearly shows a wide divergence within the category. While some funds were volatile, others remained stable and conservative.
Notably, well-managed funds not only provided better downside protection during the sharp market fall of 2020 but also captured meaningful upside during recoveries. This suggests that conservative investors can earn superior, tax-efficient returns versus pure debt—provided fund selection is done carefully.
However, because equity savings funds do carry exposure to equities, even the most conservatively managed schemes are not immune to short-term drawdowns. Market movements remain unpredictable, and investors must be prepared for periods of negative returns. As a result, conservative investors should approach this category with a minimum investment horizon of three years to allow the strategy to play out across market cycles.
Portfolio balance
Current market conditions further strengthen the case for equity savings funds. Equity market corrections improve entry valuations for the equity portion of portfolios, while higher volatility benefits arbitrage strategies. Together, these factors enhance the medium-term upside potential for equity savings funds when markets eventually enter a sustained bull phase.
That said, equity savings funds should not be viewed as a substitute for debt or fixed income products. At most, they should form about one-fourth to one-third of a conservative portfolio, and only for investors who can tolerate slightly higher risk than traditional debt instruments and are willing to stay invested for at least three years.
Debt and fixed income products must continue to remain the core of conservative portfolios, offering safety, stability and consistency. Their performance, however, is cyclical, with higher returns typically realised during periods of elevated interest rates.
Rushabh Desai is founder of Rupee With Rushabh Investment Services. Views expressed are personal.
topics
