Debt funds enter accrual zone: Where to invest as yields stay elevated

India's debt markets are navigating a delicate moment. On 8 April, the Reserve Bank of India's Monetary Policy Committee (MPC) held the policy repo rate unchanged at 5.25%, maintaining its neutral stance as it weighed a resilient domestic economy against the inflationary overhang of the West Asia conflict. The decision was unanimous. In his statement, RBI Governor Sanjay Malhotra said the MPC judged it “prudent to wait and watch the changing circumstances and the evolving growth-inflation outlook.”

That caution is filtering through bond markets. The 10-year government securities yield has firmed to 7.05% as of April 6, up from 6.66% in late February, as elevated crude oil prices, a widening trade deficit, and foreign portfolio outflows of approx. US$ 5.4 billion in the first week of 2026-27 have unsettled sentiment. Meanwhile, swap curves are already pricing in a meaningful probability of rate hikes if the conflict persists.

For debt mutual fund investors, the key question is not whether to invest, but ‘where and with what expectations?’

Carry over capital gains

Most fund managers state that this is an accrual market, not a capital gains market. “For most investors, the role of debt today is stability, income and diversification, not timing rate cycles,” says Devang Shah, Head of Fixed Income at Axis Mutual Fund. He notes that yields across the curve are currently in the 7–7.50% band, making fixed income ‘meaningfully attractive’ for those willing to stay invested. Shah advises against unnecessary churn: “Avoiding unnecessary churn and allowing accrual to compound steadily is more effective than reacting to every policy or geopolitical headline.”

Manish Banthia, Chief Investment Officer for Fixed Income at ICICI Prudential AMC, believes current pricing presents an opportunity rather than a risk. “The entire curve is elevated, and most parts of the curve are at their highs over the last five to six years. The market is overpricing the risks of interest rate shifts,” he says, adding that this makes high-duration funds attractive at this point alongside the short-to-medium term space.

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Which categories stand out

Within the universe of the debt fund sub-categories, fund managers are converging on a similar set of preferred segments. Banthia favours the corporate bond, short-term and Banking & PSU categories, and also sees merit in dynamically managed gilt funds given current yield levels. “The 2–4 year duration is the best suited segment for investors at the current juncture on the corporate bond side,” he says.

Pranay Sinha, Senior Fund Manager for Fixed Income at Nippon India Mutual Fund, says. “The intermediate category of funds like short duration, corporate bond and Banking & PSU will benefit most from the recent spike in yields,” he says. Sinha says,

“These funds offer good carry at moderate duration, thus limiting the amount of volatility while still offering scope for mark-to-market gains if yields come down from elevated levels.”

For investors with higher risk tolerance, Shah sees tactical merit in long-duration funds. “With absolute yields on long-duration funds now above 7.75–7.80%, these levels present attractive entry points for investors comfortable with volatility, particularly until the war settles,” he says. He also highlights Income Plus Arbitrage strategies as a tax-efficient option for two-to-three-year investors seeking stable accrual without mark-to-market exposure.

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The macro backdrop

The RBI's own projections set the parameters. Real GDP growth for 2026-27 has been projected at 6.9%, down from 7.6% in 2025-26, with the West Asia conflict identified as the primary headwind through energy prices, supply chain disruptions, and a widening current account deficit. CPI inflation for the year is projected at 4.6%, with Q3 at 5.2% presenting the most challenging quarter. The Governor noted that “upside risks to the inflation outlook, driven by increased energy price pressures and probable weather disturbances affecting food prices, have increased.”

For debt investors, this translates to a period where rate cuts are not imminent, capital gains on bonds are limited, and the real opportunity lies in locking in elevated carry across short-to-medium duration segments before the cycle turns.