Investors encouraged to focus on corporate bond funds

Debt mutual fund investors can maximize their returns by adopting specific strategies in response to changing interest rates. As of February 2025, the yield on Indian bonds has dropped to 6.7%. This comes as interest rates are expected to continue to decline. Given that debt mutual funds do not offer indexation benefits, it's crucial for investors to consider how to enhance their fixed income returns. There are two main strategies to improve returns: taking credit risk and taking duration risk. Credit risk involves investing in lower-graded, riskier debt instruments. In contrast, duration risk focuses on safer, high-graded long-maturity debt instruments. Recent data shows how these approaches have performed. From January 2018 to February 2025, credit risk funds yielded an average return of 7%. Corporate bond funds had an average return of 7.3%, while constant maturity gilt funds averaged 7.8%. Current average returns for these funds hover around 6.3% for credit risk funds, 6.7% for corporate bonds, and 6.5% for gilt funds. Corporate bond funds and constant maturity gilt funds have shown better risk-adjusted returns compared to credit risk funds. Investing in high-quality corporate bonds or gilt funds reduces credit risk. Investors should prefer funds with investments in AAA-rated or government bonds to further minimize risk. While duration risk can impact returns temporarily during interest rate hikes, remaining invested through these cycles can mitigate this concern. When interest rates drop, existing bonds with higher yields become more valuable. Therefore, the timing of investments in longer maturity funds is key, especially before anticipated interest rate cuts. In conclusion, investors should build a core portfolio that features medium-maturity corporate bond funds and be strategic about including long-maturity funds as tactical investments. The current interest rate cuts may lead to further opportunities for growth in fixed income investments over the next few years.