Normally, both debt funds and conservative hybrid funds are poised to benefit mainly due to the inverse relationship between interest rates and bond prices.
Debt funds invest mainly in bonds and other fixed-income securities, and benefit when interest rates go down. As rates fall, the prices of existing bonds rise because these bonds offer higher coupon rates than new bonds issued at the lower rates. This leads to capital appreciation for the bonds held by the fund, which causes an increase in the fund’s NAV and delivers better returns to investors.
Debt mutual funds and conservative hybrid funds typically become more attractive in a falling interest rate environment due to the inverse relationship between interest rates and bond prices. Nikhil Aggarwal, Founder & Group CEO, Grip Invest, says, “When rates fall, the market value of existing bonds rises, leading to capital gains, especially for funds holding medium to long-duration securities. For example, a fund with a 4-year duration gains ~2% NAV for every 0.5% rate cut.”
Conservative hybrid funds, which usually allocate 75-90% to debt and 10-25% to equity, can benefit from low interest rates in two ways. The debt portion of the portfolio sees capital gains as bond prices rise, similar to debt funds. The equity allocation has the potential to generate higher returns if lower interest rates stimulate economic growth and improve corporate profitability, which can lead to higher stock prices. This combination of stable debt returns and potential equity upside makes conservative hybrid funds appealing.
Himanshu Srivastava, Associate Director – Manager Research, Morningstar Investment, says, “The onset of a rate cut cycle in India could indeed enhance the appeal of debt funds and conservative hybrid strategies, particularly for investors seeking risk-adjusted returns with lower volatility. As interest rates decline, bond prices rise, benefiting duration-oriented debt funds, especially categories such as dynamic bond, gilt, and medium-to-long duration funds. The potential for comparatively better return in this scenario, in addition to accrual income, makes these funds an attractive proposition in a falling rate environment.”
“For conservative hybrid funds (which typically allocate 10–25% to equities and the rest to debt), the falling interest rate backdrop could also be supportive. The debt portion stands to benefit from a potential rate cut if positioned appropriately, while the equity component provides a kicker from improved sentiments and market upturn. These funds may appeal to cautious investors who are looking for relatively stable returns with limited equity exposure,” said Srivastava.
