The US Federal Reserve made headlines on September 18 by lowering interest rates by 50 basis points (0.50%). This move has brought US interest rates down to the range of 4.75%-5%. With the US central bank reducing rates just before the upcoming presidential elections, experts believe that this decision will have implications not only for the US economy but also globally, including in India.
Impact on Indian Bond Market
A key question on many investors’ minds is: what does this mean for the bond market in India, and how will it affect the returns on mutual fund debt schemes? The Fed’s decision has raised expectations that the Reserve Bank of India (RBI) might follow suit with a repo rate cut later this year. A reduction in repo rates directly influences the bond market, especially long-term bonds, and can impact the performance of debt mutual funds.
Bond Fund Returns Could Improve with Falling Interest Rates
When interest rates decline, borrowing costs decrease, leading to lower fixed deposit rates from banks. This can make debt mutual funds, particularly bond funds, more attractive to investors. As a result, bond yields soften, and bond prices tend to rise. It’s important to note that bond prices and yields move inversely: when bond prices go up, their yield decreases, and when bond prices fall, yields rise.
Why Long Duration Funds Might Be a Good Choice
Experts suggest that when interest rates are expected to fall, long-duration debt funds could offer better returns. This is because the value of long-term bonds typically rises more with a decrease in interest rates. As bond yields decline, long-duration funds see an increase in NAV (Net Asset Value). Although short-duration funds may also witness an uptick in NAV, the effect is generally less pronounced than in long-duration funds.
Characteristics of Long Duration Funds
Long-duration funds primarily invest in government bonds and other debt instruments with longer maturity periods, often over 7 years. Additionally, they may include investments in money market instruments. Given the potential for higher returns in a falling interest rate environment, experts recommend that investors consider adding long-duration funds to their portfolios. This can be especially useful for those looking to take advantage of expected rate cuts by the RBI and benefit from the resulting bond market movements.
By keeping an eye on global trends and potential domestic interest rate cuts, savvy investors can position themselves for better returns in the debt fund space, particularly with long-duration funds.
(Disclaimer: Investments are subject to risks. Always consult with a financial expert before making any investment decisions.)
