Hit by falling FD rates? Consider these funds with 3-year horizon

Hit by falling FD rates? Consider these funds with 3-year horizon

With the Reserve Bank of India (RBI) cutting the repo rate by 100 basis points (bps) since the beg­in­ning of 2025, banks have low­ered their fixed deposit (FD) rates. Fixed-income investors may consider mutual fund (MF) alte­rna­tives such as equity savings funds (ESFs) and conservative hybrid funds (CHFs) to earn bet­ter returns with moderate risk. 

“These funds can be partial alternatives to fixed income instruments in a falling interest rate environment, but not full substitutes. As rates fall, bond prices rise, boosting returns, and the small equity exposure adds a kicker,” says Chintan Haria, 

principal – investment strategy, ICICI Prudential Asset Management Company (AMC). 

“These funds can be a one-stop solution for investors looking for steady long-term income or appreciation with moderate risk,” says Devender Singhal, fund manager, Kotak  Mutual Fund.

 

ESFs and CHFs offer better retu­rn prospects. “Their structured mix offers the potential for better yields than traditional savings instruments, which may become less attractive as interest rates decline,” says Jayesh Sundar, fu­nd manager, Axis Mutual Fund. 

Equity exposure  

with diversification ESFs invest up to 35 per cent  in equities and a portion in  spot-future arbitrage to ensure a minimum 65 per cent equity allocation. The balance is invested in bonds. The arbitrage component typically earns money market returns and is less affected by market volatility. 

“The portfolio is invested across equities, arbitrage and debt securities, providing diversification. The debt component provides relatively steady income, further augmented by exposure to equity arbitrage strategies,” says Singhal. 

Conservative approach   CHFs allocate 10–25 per cent to equities, mostly large caps, and the rest to bonds with low credit risk. “CHFs, with their higher de­bt allocation, are better suited for very cautious investors and can benefit from falling interest rates during debt rallies,” says Haria.

 

Risks and volatility 

Market downturns can impact the net asset values (NAVs) of these funds. “They carry market-linked risks and are not absolute substitutes for guaranteed  products,” says Sundar.  

 

“These categories may underperform in strong bull markets due to their conservative asset mix. ESFs can incur short-term losses in crashes (e.g., over 10 per cent in 2020) and have limited upside. In the past, poor-quality debt picks have led to partial capital losses,” says Haria. 

Tax implications 

Tax treatment varies for the two categories. “Gains on redemption of units of ESFs having equity exposure greater than 

65 per cent are taxed as equity-oriented schemes. They are taxable as long-term capital gains (LTCG) at 12.5 per cent for units held for more than one year, and as short-term capital gains (STCG) at 20 per cent for units redeemed within a year,” says Sundar. Surcharge and cess are also levied, if applicable. 

CHFs with debt exposure greater than 65 per cent are categorised as ‘specified mutual funds’. Gains arising on transfer or maturity of units acquired  on or after April 1, 2023 are deemed to be STCG (regardless of holding period) and taxed at applicable slab rates. 

For conservative investors 

These funds suit investors with moderate risk tolerance. “They are apt for conservative investors taking their first step into mar­ket-linked products or those looking to balance portfolio risk. Generally, 10–30 per cent of the portfolio can be considered for such funds within the debt or income-oriented segment,” says Sundar. 

Investors seeking guaranteed returns or unable to tolerate even minor NAV fluctuations should avoid them. “These funds aren’t principal-protected like FDs and are suitable only for investors with a 3-plus-year horizon who can handle some volatility in between,” says Haria. 

 

 

The writer is a Gurugram-based independent journalist