RBI policy outcome this week: Which debt funds should bond investors consider as 25 bps rate cut on cards?

“Inflation swindles the bond investor… it swindles the person who keeps their cash under their mattress, it swindles almost everybody,” said veteran investor Warren Buffett. Well, this very inflation is what bond investors will be watching closely. Interesting times await the Indian bond market as inflation eases to multi-month lows, making it crucial for investors to keep a close eye on their portfolios. “The recent RBI growth report is likely to print a firmer-than-consensus 7.5% YoY, though with annual inflation below 2% and the current quarter’s to average below 1%,” says Radhika Rao, Executive Director and Senior Economist at DBS Bank. She maintains her view for a 25 bps (bps – basis points. One basis point is one hundredth of a percentage point) rate cut by the RBI at the December meeting. Commentary will be balanced, to prevent a redux of post-June hardening in bond yields, which, alongside OMOs, should bode well for bonds, taking 10-year yields down by at least 20-30 bps from prevailing levels. “In FY26, the average inflation is approx 1.92% — much below RBI’s lower target band of 2-6%,” says Ashish Padiyar, Managing Partner, Bellwether Associates, noting that inflation is cooling down rapidly. “So this gives a clear-cut case for a rate cut in the MPC meeting scheduled in December. “As a result (low inflation, its management, etc), the thrust of the December meeting is likely to revolve around laying the groundwork for a calibrated easing cycle, even as the central bank maintains a cautious tone and reiterates vigilance on evolving inflation dynamics,” says Harsimran Singh Sahni, Executive Vice President – Treasury Head, Anand Rathi. The broad consensus signals the scope of a rate cut in December by the RBI due to inflation coming under control. Commenting on the impact for the bond market, Rao says a combination of developments (onshore INR bonds steadying, currency defence, portfolio equity outflows, FX intervention) has cemented expectations that official bond purchases via open market operations might be in the pipeline in December, to rein in yields. Strategy for bond investors How does this possible rate cut guide investment decisions? Tushar Sharma, Co-founder, Bondbay, says if the RBI begins a rate-cut cycle, the biggest beneficiaries will be duration-sensitive debt fund categories. This is because Long Duration Funds, Gilt Funds (especially 10-year+), Dynamic Bond Funds and Medium-to-Long Duration Funds tend to gain meaningfully. After all, falling rates push up bond prices. Corporate Bond Funds and Banking & PSU Funds may also see mark-to-market gains, though to a smaller extent. “Conversely, Overnight, Liquid and Ultra-Short funds will see their yields gradually decline as money-market rates reset lower,” says Sharma. The impact for the equity categories will not be as direct, though easing rates often support rate-sensitive sectors like banks, autos and real estate. “A potential rate cut would influence all debt mutual fund categories, but the extent of the impact will vary across the maturity spectrum,” says Sahni. If the RBI easing cycle begins, shorter-duration funds—especially those in the 3–5-year bucket—stand to benefit the most compared with longer-maturity where future rate cut expectations, demand supply mismatch matter a lot. These categories are well-positioned to capture price gains as front-end yields decline. “In such a scenario, the yield curve is likely to steepen, with shorter-term segments outperforming the long end. As a result, investors positioned in the 3–5 year maturity range could see relatively stronger mark-to-market gains once the rate-cut cycle begins,” says Sahni. “The 3 to 4 years segment of the corporate bond market currently appears attractive, and in case of a rate cut, short to medium term duration funds provide a good opportunity,” says Padiyar. He also feels that the 10-year G-sec yield is currently near the upper end of the trading range, which could present an attractive short-duration trading opportunity. In a period of uncertainty around upcoming RBI rate decisions, investors are generally better off maintaining their existing bond allocations rather than reacting to short-term market swings, note experts. “With inflation easing and the prospect of a rate cut in the December policy, the short-term outlook for debt assets remains constructive. Staying invested allows investors to fully participate in the potential mark-to-market gains that could emerge as yields soften,” ends Sahni. How to deal with uncertainty on policy rates? In an uncertain rate environment, investors should focus on balanced duration exposure rather than making aggressive bets, advises Sharma. Staggered investing through laddering, spreading money across short, medium and long-term maturities, helps smooth out interest-rate volatility. “For conservative investors, short-duration and roll-down strategies offer stability with lower mark-to-market risk. Those with a longer horizon can allocate selectively to gilt or dynamic bond funds, which benefit if rates fall,” says Sharma. Above all, credit quality matters: sticking to AAA/sovereign issuers reduces downside risk. “In uncertain cycles, diversification and disciplined holding periods matter more than trying to time the exact rate cut,” adds Sharma. “Investors in times of uncertainty need to invest in staggered maturities to manage reinvestment risk and maintain liquidity and regularly review and adjust the bond portfolio to respond to changing market conditions,” says Padiyar. How will the AMC managers react? When rate cuts are anticipated, most debt fund managers do not rush to sell, says Sharma, as he comments on the strategy of debt fund managers. Instead, they typically add duration gradually, since longer-maturity bonds gain the most when yields fall. Portfolios are marked-to-market daily, so managers usually prefer a measured, wait-and-watch approach, extending duration only when conviction on the rate path strengthens. Categories like Dynamic Bond Funds may rebalance more actively, while Corporate Bond and Banking & PSU Funds focus on maintaining credit quality. “Overall, managers aim to capture potential price gains from falling yields without taking excessive duration risk too early,” explains Sharma. (Manik Kumar Malakar is a freelance writer. He writes on bonds and personal finance.) Disclaimer: This story is for educational purposes only. The views and recommendations expressed are those of individual analysts or broking firms, not Mint. We advise investors to consult with certified experts before making any investment decisions, as market conditions can change rapidly and circumstances may vary.