In current times, look at debt investments for accrual only

Joydeep Sen
2 min read20 Mar 2026, 05:56 AM IST
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In debt mutual funds, price movements can add to or reduce returns, but accrual remains the main driver.
Summary
With RBI likely pausing rate cuts after aggressive easing, bond gains from falling yields fade, pushing investors to focus on accrual, shorter duration and selective credit risk

In uncertain times, such as periods of war, the basic strategy is to stay diversified across equity, debt and gold. Returns from equity and gold depend mainly on price movements, which are harder to predict. That makes them more volatile.

Debt works differently. Most of the return comes from the coupon, or interest—known as accrual. In debt mutual funds, price movements can add to or reduce returns, but accrual remains the main driver. In the current environment, it is important to look at debt with this perspective.

Rate cycle and debt funds

When a central bank cuts rates, bond yields typically fall. Since bond prices and yields move in opposite directions, falling yields lead to price gains, which add to accrual returns in debt funds. These gains are called mark-to-market gains.

The Reserve Bank of India (RBI) has cut the repo rate by 1.25 percentage points since February 2025. But the environment is changing. Inflation, at 3.2% in February 2026, is expected to move above the 4% target in the coming months. Crude oil prices remain elevated amid the conflict in West Asia, and the rupee is under pressure.

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This suggests the rate-cut cycle is over, with a prolonged pause likely.

If rates do not fall further, bond yields are unlikely to decline meaningfully. That reduces the scope for price gains in debt funds. In fact, there is a risk that yields could rise in FY27.

In FY26, the RBI supported the bond market through open market operations (OMOs), absorbing a large share of government bond supply. The extent of such support going forward is uncertain. If it is lower, yields could inch up—slightly weighing on returns.

How to approach debt funds

A common rule is to match your investment horizon with the fund’s portfolio maturity. For example, if a fund’s maturity is around four years, your investment horizon should be similar or slightly shorter.

In the current scenario, it may be better to choose funds with shorter maturity than your investment horizon.

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This is because of modified duration—a measure of how sensitive bond prices are to changes in yields. When yields rise, longer-duration funds see sharper price declines. Shorter-duration funds are less affected.

Over time, as yields rise, newer investments in the fund earn higher coupons, improving accrual.

Enhancing returns

If yields are not expected to fall, one way to improve returns is to move slightly down the credit quality ladder. Lower-rated bonds typically offer higher yields.

There are two ways to do this:

Through Portfolio Management Services (PMS) or Alternative Investment Funds (AIF), which often invest in higher-yielding, lower-rated instruments.

By buying corporate bonds directly via online bond platforms or through wealth managers.

Direct bond investing has one key advantage. If you hold the bond to maturity, you receive the contracted return, regardless of interim price movements. This is known as hold-to-maturity (HTM), and it removes market volatility from the final outcome.

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In contrast, funds are perpetual. As bonds mature, they are replaced with new ones, so mark-to-market fluctuations remain part of the return profile.

Joydeep Sen is a corporate trainer (financial markets) and author.

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