Rising bond yields can temporarily weigh on debt fund returns, with long-duration funds typically experiencing the largest impact. Selecting a fund whose duration matches your investment horizon can help investors manage volatility, prompting the question of which debt fund is best suited to a given set of goals.

The relationship between bond prices and yields is inverse: when yields rise, the prices of existing bonds fall, and when yields decline, bond prices rise. Because a debt fund's net asset value reflects the market value of the bonds it holds, a rise in yields across the market can pull down the fund's mark-to-market value, even if the underlying securities continue to pay interest as scheduled. Yields in the market typically move in response to factors such as central bank policy rates, inflation expectations, government borrowing, and overall demand for bonds, so shifts in any of these can transmit quickly into debt fund NAVs.

The size of this impact depends largely on a fund's duration, which measures the sensitivity of a bond portfolio's price to changes in interest rates. As a rough rule of thumb used in fixed-income analysis, a bond's price changes by approximately its duration for each percentage-point move in yields. Funds holding longer-duration papers, such as government bond funds and gilt funds with longer maturities, tend to see sharper price swings when yields move. Shorter-duration funds, such as overnight, liquid, and ultra-short duration funds, are generally less sensitive to rate changes. In India, these categories sit within a framework of debt fund types defined by the Securities and Exchange Board of India (SEBI), which classifies open-ended debt schemes by their Macaulay duration, making it easier for investors to compare a fund's interest-rate risk profile.

One offsetting factor when yields rise is accrual: funds earn the coupon interest on their holdings, and newly purchased bonds come at higher yields, which can gradually cushion the mark-to-market hit on existing holdings.

This means investors with short-term goals may find shorter-duration funds more aligned with their needs, while those with longer horizons who are prepared to ride out interim volatility often consider longer-duration funds, since holding a bond to maturity locks in its yield regardless of interim price movements.

For debt fund investors, the key considerations when yields are rising are the investment horizon, the fund's duration profile, and comfort with temporary fluctuations in returns. Matching these elements can help manage volatility during periods of rising yields.

Source: CNBC-TV18 Markets