With interest rates already starting to fall after two rate cuts by the Reserve Bank of India (RBI) in April and June 2025, many experts believe it is a good time to look at debt mutual funds again. Long-duration debt funds are now well-positioned to benefit from capital gains as bond prices rise in a falling rate environment. This makes it a smart time for investors to lock in current higher yields and prepare for potential upside in debt portfolios.

Murthy Nagarajan, Head – Fixed Income, Tata Asset Management, said, "RBI has cut the repo rates by 50 basis points and changed its stance to neutral from accommodative. The repo rate is at 5.50%, the ten-year Government bond yield is at 6.35%, and the 40-year bond yield is at 7.10%. CPI inflation for the current year is expected to average 3.7% as per RBI estimates."

"Monetary policy members, in their comments, indicated that low CPI inflation gives room to cut repo rates and maintain surplus liquidity conditions, but due to global uncertainty, they have changed their stance to neutral. This stance change may enable them to react to incoming data. The IMF has revised its global growth forecast to 2.8% from 3.1% in January 2025. Given dollar weakness and low inflation, the next policy move from the RBI should be a rate cut. Investors may rebalance and increase exposure to debt as most of the negative news flows are already in the price of the securities," said Nagarajan.

At the same time, the stock markets are also trading near record highs. While this reflects optimism, it also means that many investors’ portfolios may have become overexposed to equities due to recent gains. Rebalancing by increasing allocation to debt can help bring back balance, reduce overall risk, and add stability. Debt funds are especially useful for long-term financial goals like retirement, children’s education, or wealth preservation, as they tend to be less volatile and offer more predictable returns.

"Asset allocation for investors should be driven by an investor's risk-return objectives and investment time horizon," said Kaustubh Belapurkar, Director – Manager Research, Morningstar Investment Research India. "That said, given the bull run in equity markets over the last few years, many investors are overallocated towards equities by virtue of equity appreciation and/or exuberance. Coupled with the fact that we are in a downward-trending interest rate regime, now would be a good time for investors to go back to the drawing board and assess their portfolio allocations and rebalance if necessary."

Even though the tax rules for debt mutual funds changed—removing the benefit of indexation—investors are once again seeing value in these products. Now, all gains on investments made after April 1, 2023, are taxed at the investor’s income tax slab rate, without the benefit of indexation.

This is particularly true for options like target maturity funds, short-duration funds, and high-quality corporate bond funds, which offer better visibility on returns. For many individuals, these still provide better post-tax returns than traditional fixed deposits, especially over the long term. The combination of income stability and improving return potential is drawing attention back to debt as a core part of asset allocation.

"With policy rates having likely peaked and systemic liquidity remaining in surplus, the investor can assess and increase strategic allocation to debt funds or a debt-oriented fund of funds structure for better tax efficiency," said Anurag Mittal, Head – Fixed Income at UTI AMC. "Debt funds, in the long run, can offer higher portfolio stability and lower correlation with equity risk, making them an essential counterbalance to equity exposure."

Belapurkar also advised investors to review their asset mix regularly. "As a matter of discipline, investors should assess their portfolio allocations at least once a year. Also, when looking at allocations, do not limit the exercise to only the asset class level—drill deeper into sub-asset class allocations. For instance, many investors have significant allocations towards mid and small caps. These overallocations must be course-corrected," he added.