Debt Fund Managers Shorten Duration After RBI Rate Hike

Key Takeaways

• The RBI raised the repo rate by 25 basis points to 5.50% in October and shifted to a calibrated tightening stance. 
• Several fixed-income managers are favouring shorter maturities as rising yields increase volatility in longer-duration bonds. 
• Axis Mutual Fund is focusing on high-quality corporate bonds in the one-to-three-year maturity segment. 

Debt mutual fund positioning is becoming more defensive after the Reserve Bank of India raised interest rates and signalled a tighter monetary-policy environment. 

The RBI increased its policy repo rate by 25 basis points to 5.50% on October 7, marking its first rate increase since February 2023, and shifted its policy stance from neutral to calibrated tightening. 

The change has altered the rate backdrop for fixed-income portfolios. 

Bond prices and yields move inversely. When yields rise, existing bonds with lower coupons generally lose value, with longer-maturity securities typically experiencing larger price changes than shorter-duration instruments. 

Fund managers cited by The Economic Times have consequently shown greater preference for short- to moderate-duration portfolios and high-quality securities rather than aggressive long-duration positioning. 

Axis Mutual Fund, for example, is favouring high-quality corporate bonds in the one-to-three-year segment. The fund house remains neutral on government securities and cautious on longer-duration state development loans, while focusing more heavily on accrual income at the shorter end of the yield curve. 

The shift follows a broader increase in bond-market volatility as domestic inflation, crude-oil prices, currency movements and global monetary tightening affect interest-rate expectations. 

Earlier rate-hike cycles provide some context for why duration has returned to focus. 

During 2021 and 2022, long-duration mutual funds generated category returns of about 0.61% and 1.83%, respectively, according to data cited by ET. Short-duration funds returned approximately 4.6% and 4.1% during the same years. 

Those historical figures do not determine how different categories will perform during the current cycle. Bond returns depend on starting yields, subsequent rate changes, portfolio duration, credit quality and the timing of securities purchases. 

The immediate change for debt funds is the interest-rate environment itself. With the policy cycle having turned tighter, fund managers are reassessing how much duration risk they are prepared to hold while yields remain elevated.