Should debt mutual fund investors worry about imminent RBI rate hike?

Recently, a research note from Morgan Stanley said that RBI may go for three rate hikes from December quarter due to an expected recovery in private capex. A rate hike is always bad news for debt mutual funds, especially long-term schemes. Should debt mutual fund investors worry?

“It is well known for some time now that RBI will be increasing interest rates, and I think that the same has largely been discounted by the markets. We will have to see the inflation data as well to make it more meaningful,” says Lakshmi Iyer, CIO (debt) & head - products, Kotak AMC. Iyer ads that the quantum of rate hikes is also unknown.

Moving to basics, interest rate and bond prices move in opposite direction. In a rising interest rate scenario, old bonds become less attractive as they offer lower interest and in turn their prices fall. So, a rising interest rate scenario does not favour debt schemes.


Those debt schemes which carry high duration will be affected the most, say fund managers. “Interest rate hikes affect long-duration bonds. Gilt and bond funds are affected the most,” says Mahendra Jajoo, Head-Fixed Income, Mirae Asset AMC. Iyer says that even short-duration and income schemes will be affected, but not as much as the long-duration schemes.

Fund managers say that due to the high expectation of a rate hike, they are already following a stable strategy and have reduced their schemes’ exposure to long duration. “As the rate hikes are likely to happen, we are already playing on defensive duration in our schemes,” says Iyer.

Fund managers are asking investors to stay conservative and remain with short-term funds with a maturity of one to two years. “Investors should stay in low-duration or liquid schemes which invest in lower maturity instruments,” says Jajoo.

Fund managers ask investors with a slightly longer term investment horizon to stay calm and carry on with their asset allocation. “Those who have invested for slightly longer term of three to five years need not worry and stay invested as per their asset allocation as markets are cyclical in nature,” adds Jajoo.