Fixed to nix risks, earn returns

Most analysts seem to converge on the fact that the lower interest rate regime is winding down. Central banks, including the Reserve Bank of India, may go slow on further reductions, although there may be -12 cuts in the future. With much of the so-called duration rally already priced in, Axis Mutual Fund expects the investor preferences to shift decisively toward accrual-focused strategies. Short-tenor corporate bonds with better interest rates, and selective exposure to high-quality credit, which are safer and secure, are likely to remain in focus as the yields stabilise due to dovish mindset.

The fund house expects the 10-year G-sec yield to trade in a 6.4-6.6 per cent band, supported by benign, even zero or negative, inflation, continued market operations by Indian central bank, and the possibility of the country inclusion in global bond indices. There are media reports that key indices wish to include Indian bonds, which may nudge the foreign and Indian investors to shift buying and purchases. During a period, when equities remain volatile, as they were in the past several weeks, or plateau, as they did for the first 10 months of the calendar year (2025), fixed debt instruments and paper may find their sheen, and shine in the process.

“Investors should prioritise short- to medium-term debt funds, while maintaining tactical exposure to gilts for stability and diversification,” states the Axis Mutual Fund outlook for 2026. It underscores that fixed income remains well-positioned to deliver stable, risk-adjusted returns in a maturing rate cycle, with disciplined accrual strategies at the core of portfolio construction. More investors may shift towards stability and safety over the next few months, even as brokerage houses predict the Sensex to gain by 15-20 per cent in the next calendar year (2026). Retail investors generally enter the bull phase in the middle, rather than the beginning, and resort to safer havens before making aggressive and higher risk-prone moves. Thus, debt may be the in thing.

This may seem contradictory to the trends in 2025. As per the latest data from the Association of Mutual Funds in India (AMFI), debt mutual fund categories witnessed outflows, barring the ultra-short duration fund, low duration fund, money market fund, short duration fund, corporate bond fund, and floater fund. There was a marginal net outflow in the debt mutual fund category overall, but AUM of the category remained steady at INR19.36 lakh crore for the month of November 2025, owing to month-to-month gains.

Since April this year, the monthly flows in debt funds have varied widely. In three months, April, July, and October, there were positive inflows that ranged from INR1,00,000 crore to more than INR2,00,000 crore. In the months of May, June, August, and September, there were net outflows that ranged from less than INR 2,000 crore to more than INR1,00,000 crore. But the fluctuations were tricky. For example, liquid funds witnessed the highest inflows in October, followed by outflows of more than INR14,000 crore in the next month.

In this setting, fixed income is poised to play a more meaningful role in investors’ portfolios. Stable interest rates, tightening systemic liquidity, and sustained demand for bonds are expected to shift investor preference toward accrual-based strategies. Additionally, India’s rising probability of inclusion in the Bloomberg Bond Index, potential index-related inflows, and balanced supply-demand dynamics strengthen the outlook for domestic bond markets. “Fixed income is well-positioned to enhance portfolio stability and risk mitigation in 2026,” says Amit Modani, senior fund manager (fixed income), Shriram AMC. He adds that strong macro fundamentals provide a constructive backdrop for bond investors in the year ahead.

The year 2025 began amid a sharp shift in the global political and economic landscape, with Donald Trump assuming the US Presidency, and trade tensions resurfacing across key economies. Global growth moderated during the year, while emerging markets faced renewed pressure from tariff-related disruptions and persistent geopolitical uncertainty. India stood out for its macroeconomic resilience. The economy recorded robust growth alongside easing inflation, creating room for supportive monetary policy. The RBI responded with calibrated rate cuts and liquidity measures aimed at ensuring stability across the banking system and money markets. “The year is ending on a far more sanguine note than what the early part of 2025 had suggested, despite material disruptions from trade disputes and geopolitical tensions,” says Modani. 

Looking ahead, 2026 is expected to be characterised by stability rather than aggressive policy shifts. A relatively stable global environment, with the US Federal Reserve rates likely to remain unchanged for most of the year, combined with accommodative domestic monetary policy, provides a supportive backdrop for India. Policy rates are projected to enter an extended pause phase. Growth is expected to moderate into a 6.3-6.5 per cent range, while headline inflation is projected to gradually stabilise around 4-4.5 per cent. This trajectory suggests an extended pause in policy rates.

“With growth moderating and inflation settling near the RBI’s comfort zone, policy rates are likely to remain on hold through most of 2026, resulting in a ‘lower-for-longer’ rate environment,” Modani says. The benchmark 10-year government bond closed at 6.49 per cent, reflecting a cautious but steady rate environment. The RBI reduced the repo rate by 25 basis points to 5.25 per cent, while injecting liquidity through open market operations (OMOs) and a dollar-rupee swap, aimed at easing tightening pressures in the system. “Bond markets are drawing comfort from a combination of lower inflation, proactive liquidity management by the RBI and improving growth visibility,” Axis Mutual Fund said in its review.

Inflation fell to a record low of 0.25 per cent, aided by moderation in food prices and favourable base effects. The sharp disinflation has strengthened the case for the central bank to maintain an accommodative stance over the near term. At the same time, growth momentum surprised positively. GDP growth came in at 8.2 per cent, supported by strong services sector activity and favourable statistical effects. “The sharp fall in inflation alongside resilient growth has created room for policy support, but the window for aggressive duration plays is now behind us,” the Axis MF report notes.

Thus, on an overall basis, the investors’ initial reaction may be to veer towards debt funds, and fixed income instruments. Unless, of course, the IPO (Initial Public Offering) market gathers more steam, and gets heated, which will attract retail investors. By the middle of 2026, if equities emerge as bullish, the attraction will immediately shift from debt, as investors will be willing to chase returns, and give up on risks, even if the strategy is fraught with issues.