In India’s vibrant growth story, equities often steal the limelight as the undisputed engine of wealth. They are the go-to for beating inflation and turning dreams into capital. Yet, if the last two years’ market rhythms have taught us anything, it is that the road to prosperity is rarely a straight line. It is a journey shaped by economic shifts and sudden global ripples.
Relying solely on equities is like steering a ship with only a sail and no keel. This is where the often-underestimated debt mutual fund steps in. Far from a mere “parking spot” for idle cash, debt is the strategic backbone of a resilient portfolio. Think of it as your portfolio’s anchor. While equities provide the speed, debt offers the stability and liquidity required to stay the course.
When market volatility spikes and panic sets in, your debt allocation acts as a vital shock absorber. It tempers the noise, keeps you grounded, and, most importantly, provides the dry powder needed to rebalance when opportunities arise. In the dance of investing, you need the equity sprint paired with the steady rhythm of debt to ensure you reach your destination with your strategy intact.
Common concerns
Past credit events that impacted the returns of a handful of debt schemes have discouraged many investors. However, those episodes were largely concentrated in funds that took elevated credit risk. Since then, SEBI has tightened regulations through stricter investment norms, mandatory stress-testing and the introduction of side-pocketing, making such events less likely. The takeaway is not to avoid debt funds, but to choose categories that match your investment goals and risk appetite.
Another argument often raised is that investors can simply invest in hybrid funds instead of maintaining separate debt fund allocations. Hybrid funds certainly offer the convenience of combining equity and debt within a single product. However, they cannot fully replace standalone debt funds. Investors have limited control over the debt allocation and maturity profile within hybrid funds. Separate debt funds allow investors to align investments with specific goals, match duration with investment horizons and rebalance portfolios more effectively. They also provide greater flexibility to create different debt buckets for different financial objectives.
While SIPs are commonly associated with equity funds, they can be equally useful in debt mutual funds. Though less volatile than equities, debt funds also go through periods of rising and falling interest rates, causing their NAVs to fluctuate. A SIP helps investors average their purchase cost across interest-rate cycles, making it an efficient tool for salaried investors building a long-term debt allocation.
Among the various debt fund categories, four stand out as suitable core holdings for long-term portfolios.
Gilt funds
Gilt funds invest exclusively in government securities issued by the Central and State governments. Since these securities carry sovereign backing, they are virtually free from credit risk. This makes gilt funds one of the safest debt fund categories from a credit quality perspective.
However, gilt funds are highly sensitive to interest rate movements because they typically invest in long-duration government securities. When interest rates decline, bond prices rise sharply, enabling gilt funds to generate significant capital appreciation. Conversely, rising interest rates can temporarily impact returns.
Gilt funds are further divided into dynamically-managed gilt funds and gilt funds with a constant 10-year duration.
Interestingly, the volatility in returns is considerably reduced when debt funds including gilt funds are held over longer investment horizons (see chart). A compilation of 10-year rolling returns based on the last 15 years of NAV history shows that gilt funds, including both sub-categories, delivered an average CAGR of 7.7 per cent, with rolling returns ranging between 6.6 per cent and 9 per cent (regular plans considered). As of May 2026, the portfolio yield to maturity (YTM), which indicates the expected return if the underlying securities are held till maturity and repayments are received as scheduled, ranged between 6.4 per cent and 7.7 per cent across the category.
Short-duration funds
Short-duration funds invest in debt securities with Macaulay duration ranging between one and three years. In simple terms, Macaulay duration refers to the average time a debt fund takes to recover the money invested.
These funds strike a balance between generating higher yields than liquid categories while avoiding the significant interest rate risk associated with long-duration funds.
Because of their relatively shorter maturity profile, they experience lower volatility from changing interest rates. Even if yields rise temporarily, portfolio turnover allows fund managers to gradually reinvest in higher-yielding securities, helping returns stabilise over time.
Short-duration funds are particularly suitable for investors who prefer relatively-stable returns without taking meaningful duration calls.
Fund managers have the flexibility to invest a portion of the portfolio in AA-rated debt papers. Investors should therefore review the portfolio quality of individual schemes and choose funds that suit their risk appetite.
A compilation of 10-year rolling returns based on the last 15 years of NAV history shows that short-duration funds delivered an average CAGR of 7 per cent, with rolling returns ranging between 6.4 per cent and 7.8 per cent. As of May 2026, the portfolio YTM for the category ranged between 6.9 per cent and 8.1 per cent.
Corporate bond funds
Corporate bond funds are mandated to invest at least 80 per cent of their assets in the highest-rated corporate debt securities, predominantly AAA and AA+ rated instruments. This significantly reduces credit risk compared with categories that invest across the credit spectrum.
These funds generally offer yields that are moderately higher than government securities because investors receive additional compensation for lending to financially strong corporate issuers. At the same time, the emphasis on high-quality issuers ensures that credit quality remains robust.
For long-term investors seeking relatively stable income without taking substantial credit risk, corporate bond funds represent one of the most suitable choices.
These funds are particularly suitable for investors who wish to earn better yields than government securities while remaining invested in the highest-quality segment of the corporate bond market. While most schemes predominantly hold the highest-rated securities, fund managers also have the flexibility to invest a small portion of the portfolio in AA-rated papers.
A compilation of 10-year rolling returns based on the last 15 years of NAV history shows that corporate bond funds delivered an average CAGR of 7.4 per cent, with rolling returns ranging between 6.2 per cent and 8.2 per cent. As of May 2026, the portfolio YTM for the category ranged between 7.1 per cent and 8 per cent.
Banking & PSU debt funds
Banking & PSU debt funds invest predominantly in debt instruments issued by banks, public sector undertakings, public financial institutions and municipal bodies. Regulations require at least 80 per cent of the portfolio to be invested in these issuers.
The category has become increasingly popular because it combines relatively-high credit quality with attractive liquidity. Most issuers belong to institutions with strong financial standing or government ownership, reducing the probability of credit events.
Banking & PSU debt funds generally maintain moderate duration profiles, making them less volatile than long-duration categories while still benefiting from favourable interest rate movements. Their balanced risk characteristics make them suitable for investors seeking consistency rather than aggressive duration bets.
For long-term asset allocation, Banking & PSU debt funds provide a compelling combination of credit quality, liquidity and relatively-stable income generation. They can comfortably serve as the core debt allocation for investors looking for dependable performance across interest rate cycles.
A compilation of 10-year rolling returns based on the last 15 years of NAV history shows that Banking & PSU debt funds delivered an average CAGR of 7.4 per cent, with rolling returns ranging between 6.8 per cent and 8.1 per cent. As of May 2026, the portfolio YTM for the category ranged between 7 per cent and 7.9 per cent.
Published on July 4, 2026
