Fixed income strategy amongst rising yields

Over the past 52 weeks, the Indian 10-year g-sec bond yield rose sharply by around 100 bps from 6.13% to 7.12%, and as on April 30, 2026, the 10-year g-sec bond yield traded at 7.02%.

Despite no rate hikes by the RBI, why did the Indian bond yield spike up? Markets are always forward-looking and will price in the future outlook. The rise in the yield is primarily driven by 1. Heavy government borrowing due to fiscal stress causing supply pressure in the bond market; 2. Elevated crude oil prices due to global geopolitical tensions leading to fear of high inflation and widening of current account deficit; and 3. Weakening of the Indian rupee against the US dollar adding a second layer of import inflation.

Indian inflation inched up from 0.25% in October 2025, to 3.40% in March 2026. Although well-within the RBI’s comfort band, one cannot deny the deep fear of rising inflation amid global uncertainties that are causing and can further cause volatility in the yields. Keeping all of the data in mind, we can conclude that the interest rate-cut cycle may have ended and yields may remain elevated and volatile. Currently, we expect the RBI to hold interest rates unchanged at least till 2026-end, but if oil prices remain high and if global central banks reverse the course and start hiking rates, India would likely follow (probably from 2027).

Fixed income investors should understand the basics that bond yields and bond prices are inversely related, which means in the current rising yield scenario, the demand for the prevailing lower interest-rated bonds will fall, which would pull down their prices, negatively impacting the returns at the mark-to-market level. Typically, in this process amongst the entire duration curve, long-duration bonds will be impacted the most, followed by medium to long-duration bonds, compared to shorter duration bonds. Over the past one year as on April 30, 2026, long-duration debt mutual funds generated negative returns in the range of -0.55% to -3.86%, compared to ultra-short, low and short-duration debt mutual funds, which generated positive returns in the range of 4.00% to 6.45%.

But aren’t debt mutual funds safe? Every asset class and product will have risk. Since debt mutual funds are market-linked products and the underlying bonds in their portfolios are traded in the secondary market, there will be some degree of risk. Debt mutual funds carry three types of risks — interest rate volatility risk, credit risk and liquidity risk, thus choosing the right funds and understanding the interest rate cycle is very important.

What should fixed income investors do in this scenario? In a rising yield scenario, the underlying bonds in debt mutual funds especially long-duration and medium to long-duration will be very sensitive to any volatility in the yields, thus the primary goal should be to minimise/avoid volatility risk. The best way to do this is by staying away from the longer end of the yield curve (medium to long and long-duration debt funds) and sticking with the shorter end of the yield curve (shorter duration debt funds). To further minimise/avoid volatility risk, investors should stay invested till the product’s full maturity period and choose products based on one’s time horizon.

Will investors need to compromise on the yields (yield to maturity) in shorter duration products? No, the overall yield curve from the shorter end to the longer end is more or less flat, which means that there is equal opportunity to earn across the yield curve.

Keeping the prevailing volatility risks in mind and from a better risk-adjusted returns point of view, ultra-short-duration, low-duration and short-duration debt mutual funds are better and safer bets. As on April 30, 2026, shorter duration (1-3 years) AAA & AA yields ranged 7.12% to 8.59%, compared to medium (5 years) and long (10 years) duration AAA & AA yields, which ranged 7.51% to 8.56%.

Investors can not only look at ultra-short, low, short-duration debt mutual funds, but also corporate bond debt mutual funds with maturity profiles not exceeding 4 years.

Last but not the least, along with all of the above, investors should stick to higher credit-rated products like Sov, AAA and AA+ to minimise/avoid credit risk and should diversify well-across different products and categories to minimise/avoid liquidity risk, as any investment made in fixed income products should be meant for capital preservation and steady appreciation.