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After a phase of monetary easing and bond market rallies, debt mutual fund investors are heading into a different environment in 2026. The broad consensus among experts is that gains from falling interest rates are largely behind us. What lies ahead is a year of relative rate stability, which calls for realistic return expectations and careful portfolio construction rather than aggressive interest-rate bets.
Why is there limited room for rate cuts?
The central bank cut the repo rate by 125 basis points in 2025. That phase has largely played out. The policy stance is now neutral, which means future moves, either cuts or hikes, will depend on incoming data.
“Any further cut depends on inflation staying below the target, and some drag on growth,” said Mayur Chauhan, fund manager – fixed income, Quantum AMC.
While inflation has been benign, the Reserve Bank of India (RBI) expects it to move closer to 4 per cent in the first half of FY26. “There may be one final rate cut on February 6, but the probability is less than 50 per cent,” said Joydeep Sen, independent debt market expert.
Why should duration bets be avoided in 2026?
The year 2025 belonged to the duration strategy. With the rate-cut cycle now at or near its end, duration-led capital gains are unlikely to be repeated. Duration strategies require clear visibility on further rate cuts, which is currently absent.
In this environment, increasing exposure to long-duration funds does not make sense for most investors. “Investors should build a large part of the portfolio in lower-duration securities and rely on the accrual theme in 2026,” said Devang Shah, head – fixed income, Axis Mutual Fund.
Duration bets carry asymmetric risks at this stage. With rate cuts largely done, markets may start pricing in the next phase of the cycle, which could include rate hikes from 2027. Any such shift would hurt longer-maturity bonds more sharply.
The rupee has been under pressure. “In periods of currency stress, short-term interest-rate bets tend to become riskier,” said Vishal Dhawan, founder and chief executive officer, Plan Ahead Wealth Advisors.
For investors who might still consider long-duration funds, the investment horizon becomes critical. “The holding period should broadly match the portfolio maturity of the fund. A fund with a 10-year maturity profile requires an eight-to-10-year horizon,” said Sen.
Are medium-duration funds a selective opportunity?
Medium-duration funds occupy the four-to-six-year maturity segment and offer a balance between return potential and interest-rate risk. “In a year where rates are expected to remain largely stable, build a portfolio with an accrual bias,” said Shah.
Yields in this segment are typically higher than those available in shorter-duration funds, which improves return potential. Chauhan pointed out that medium-duration funds are for investors who can take some risk. Macro risks such as a growth collapse, inflation surprises, commodity price shocks or sharp currency moves could lead to rate hikes. If yields rise, mark-to-market losses would follow.
Sen suggested that investors should align their holding period with these funds’ maturity profile, ideally staying invested for four to six years.
Another important consideration is credit quality. “Many medium-duration funds take higher exposure to lower-rated bonds than shorter-duration funds. Credit risk and expense ratios should be scrutinised closely,” said Dhawan.
Why should short-duration funds form core holdings?
Short-duration funds are well-suited to the current environment. Their returns rely primarily on accrual income, and they are less susceptible to mark-to-market volatility if interest rates rise.
These funds are particularly appropriate for investors with short investment horizons of six months to one year, or for money earmarked for near-term goals. “If liquidity infusion continues through 2026, as is possible, investors in short-duration funds would benefit,” said Dhawan.
Where should investors allocate and what should they avoid?
For a medium-term horizon of around two years, Shah suggested opting for income-plus arbitrage fund-of-funds, which offers tax efficiency to investors in higher tax slabs.
Horizon matching remains the most important principle. “Ultra-short and low-duration funds are suited for a horizon of less than one year; medium-duration and corporate bond funds are appropriate for three-to-five-year horizons; while long-duration funds are suited for those who want to make a long-term allocation,” said Sen.
Why is portfolio discipline crucial in 2026?
In 2026, the emphasis should be on understanding risk rather than chasing returns. “Funds showing unusually high past returns often carry higher credit or duration risk. Stable and secure returns from high-quality portfolios are more appropriate for the role debt funds play in a portfolio,” said Chauhan.
Investors should also resist the temptation to reduce debt allocation simply because equities or precious metals have delivered strong performance in recent years, as debt funds play a critical stabilising role. Expenses deserve close attention. Finally, past performance should not be extrapolated blindly, as it is typically the result of a rate environment that no longer exists.
