Debt mutual funds do well in a falling interest rate environment. Because of the inverse relationship between interest rates and prices of bonds, prices gain when interest rate falls. This pushes up the Net Asset Value of debt mutual funds. Long term debt schemes and gilt funds benefit the most from falling interest rates.
“Investors with medium to long term investment horizons can look at funds having duration of three to four years with predominant sovereign holdings as they offer a better risk reward currently. Investors with an investment horizon of 6-12 months can consider money market funds as yields are attractive in the 1-year segment of the curve,” said Pal.
The RBI policy review is scheduled on Thursday. Most money market analysts believe that the banking regulator is likely to take a pause and hold rates after the hike this week.
Indian bond yields remained stable with the 10-year benchmark bond yield stuck in a tight range between 7.30% to 7.40% and the OIS curve remained inverted. The markets have factored in a 25 bps rate hike in the MPC meeting next week as concerns on food inflation rise.
The flat to inverted yield curves across markets are reflecting the expectations of lower growth and inflation going ahead as the effects of the aggressive and front-loaded rate hikes by central banks get reflected in the banking system of the US and Europe, said Pal.
