'Existing investors who have not acted so far may consider holding on to these funds with the understanding that the higher returns they expected from them may now take longer to materialise.'
Long-duration funds have been the worst-performing debt fund category over the past year.
This Rs 13,048 crore category has delivered an average return of -2.7 per cent.
Key Points
- Long-duration debt funds delivered negative returns as rising bond yields triggered mark-to-market losses across portfolios.
- 10-year Gsec yield climbed sharply from 6.25% to 7.1%, driven by tariffs, global rate shifts, and oil price surge.
- Higher Macaulay duration makes these funds highly sensitive to interest rate changes, amplifying both gains and losses.
- Existing investors may hold to benefit from improved accruals, but returns could take longer to recover.
- New investors should wait for clarity on inflation and rates or consider staggered investments to reduce timing risks.
How these funds work
Long-duration funds have a Macaulay duration of more than seven years.
Macaulay duration is a measure that market regulator Sebi uses to classify debt mutual funds.
It indicates the portfolio's average interest-rate sensitivity in terms of time: The higher the Macaulay duration, the more sensitive the fund is to changes in interest rates.
This makes these funds highly sensitive to interest-rate movements.
"When interest rates fall, prices of underlying bonds rise and generate capital gains," says Gautam Kalia, head-investment solutions and distribution, Mirae Asset Sharekhan.
The reverse happens when interest rates rise.
"These funds may hold the promise of higher expected returns, but they are also subject to higher risks," says Kalia.
Rising yields leading to negative returns
The 10-year Gsec yield rose from 6.25 per cent in May 2025 to around 7.1 per cent in April 2026.
The upward movement began with US tariff announcements.
In August 2025, Indian tariffs were further raised to 50 per cent, which weakened sentiment and pushed bond yields up to around 6.6 per cent.
"Then the interest rate stance of global central banks also shifted significantly, as they paused cuts or reduced expectations of further cuts," says Mohit Basant Bagdi, head of investment research & founding member, MIRA Money.
The final blow came in March 2026, when escalating US-Iran hostilities pushed oil prices from $65-$70 to above $110.
"The 10-year Gsec yield in India, which was around 6.6-6.7 per cent, shot up to around 7.1 per cent on fears of higher inflation due to the oil surge and supply-chain disruption," says Bagdi.
Higher yields caused mark-to-market losses in long-duration bond funds.
Will returns improve?
A prolonged or intensified conflict could push energy prices even higher.
Higher energy prices could worsen inflationary pressures and, in turn, drive bond yields higher.
Even if geopolitical tensions ease, inflation caused by elevated energy prices may take time to subside.
"Bond yields could therefore remain under upward pressure in the near term," says Kalia.
Speculation risk
Investors enter these funds for the short term expecting interest rates to fall.
"The key risk is that interest rates may not move as expected," says Arnav Pandya, founder, Moneyeduschool.
In that case, investors who cannot extend their investment horizon may end up suffering losses.
Should existing investors exit?
With the 10-year Gsec yield moving above 7 per cent, much of the damage has already occurred.
"Existing investors who have not acted so far may consider holding on to these funds with the understanding that the higher returns they expected from them may now take longer to materialise," says Pandya.
As yields rise, portfolio accrual also improves.
"Staying invested allows investors to benefit from higher accrual than earlier, as yield levels have moved up," says Joydeep Sen, corporate trainer (debt) and author.
Should new investors enter now?
New investors may be better off waiting for some more time before entering.
At above 7 per cent, the market has already priced in many negatives.
But there is no clarity on the extent of destruction in Gulf countries.
This factor could feed into inflation and interest rates in the future.
"Until there is clarity on these issues, new investors should stay away," says Pandya.
Alternatively, they may enter in a staggered manner.
Exposure and horizon
Moderate and conservative investors may allocate about 10 per cent of their fixed-income portfolio to these funds.
"Aggressive investors may allocate about 30 per cent of their fixed income portion," says Sen.
Sen adds that the investment horizon should be approximately equal to the fund's portfolio maturity.
"That time frame increases the chance of living through a cycle of falling rates," says Pandya.
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Feature Presentation: Ashish Narsale/Rediff
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