With the US Federal Reserve signalling possible rate cuts in September 2024, the Reserve Bank of India (RBI) may follow suit by December as central banks around the world usually take cue from Fed rates. In that scenario, debt funds, which invest in fixed-income instruments, may see fluctuation in yields. So far, India’s bond market has been insulated despite the global monetary easing, thanks to stable macroeconomic fundamentals and favourable demand-supply dynamics.

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Vinod Singh, co-founder and CEO of Finhaat, a financial services company, says, “With rate cuts, impact on NAVs (Net Asset Values) will be different for different kinds of debt funds. One with lower duration, i.e., holding underlying investment with shorter maturity, will see marginal improvement in NAVs, whereas funds with quality longer maturity can expect a higher jump in the NAVs. While the market starts pricing the effect in anticipation, we can expect better returns for longer duration funds over a period.” Hence, experts like Singh recommend investing in long-term funds for retirement plans and medium-term funds for specific targets.

Demand-Supply Dynamics Favouring Bond Prices

As the domestic policy rates peaked, it created favourable demand-supply dynamics. Explains Venkatakrishnan Srinivasan, founder of Rockfort Fincap LLP, a financial advisory firm: “The demand-supply dynamics in the Indian government bond market have shown marked improvement, driven by a combination of factors. Firstly, the inclusion of Indian government bonds in the JP Morgan Emerging Market Bond Index has significantly boosted foreign portfolio investor (FPI) inflows. This inclusion has enhanced India’s visibility on the global stage, leading to increased demand from international investors who are attracted to India’s growth story.

“On the supply side, while the government continues to issue bonds to fund its fiscal needs, the increased demand from FPIs and domestic investors, including banks, mutual funds, and insurance companies, has helped absorb the supply. This has contributed to a more balanced demand-supply equation, reducing the pressure on yields.” This demand-supply equation favours bond prices, with minimal spread between repo rates and 10-year G-Sec yield.

India’s stable growth despite a global slowdown has allowed RBI to maintain the status quo. With inflation under control, the RBI will likely continue monitoring the situation before considering any rate cut, depending on global developments and the INR-USD exchange rates. However, RBI’s main concern now is food inflation and may go for a revision if growth stalls.

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Short-term and corporate bonds, Singh says, are “good options” to mitigate credit risk, allocate assets wisely, and ensure better portfolio management. However, fixed-income funds must still be part of the strategic asset allocation strategy despite the tax aspect.

So, What’s The Right Time To Invest In Debt Funds?

According to Singh, “It’s all about sticking to asset allocation. Given a significant run-up of the equity markets and asset allocation skewing more towards equity, such portfolios will do well to invest more in debt funds. An expectation of better shorter-term returns in debt funds further improves this.” Falling interest rates favour debt funds, as it lead to higher bond prices and NAVs. So it can be an opportune time to invest depending on the investors’ financial situation.

Which Debt Funds Should You Choose?

The investment horizon is critical to choosing a debt fund. There are many categories of debt instruments, such as liquid funds, money market funds, and overnight funds. One can choose an overnight fund if the motive is to invest for a few days. If it is for a few months, intended for emergencies, go for a liquid fund. Ultra-short-duration funds can be explored if the investment period is up to a year, which can also be an alternative for liquid funds or bank deposits. For an investment horizon of one to three years, money market funds and short and low-duration funds can be explored as they provide better results with controlled risks. Corporate bonds, banks, and PSU funds can be explored for those with over a three-year investment horizon.