Debt MFs: Should You Take Credit or Duration Risk?

Prioritize mid-maturity corporate bond funds for balanced risk and returns

- Rushabh Desai

The 10-year Indian bond yield, trading at 12-13% in the late 90s, has now dropped from its 5-year high of around 7.5% to 6.7% as of February-end. With the start of interest rate cut cycle, yields are likely to fall further. And with no indexation benefits in debt mutual funds, this raises an important question: "How can investors maximize on their fixed income returns?"

Typically, there are two ways to maximize debt mutual fund returns: 1) By taking credit risk (investing in risky lower-graded debt instruments), and 2) By taking duration risk (investing in safer, high-graded long maturity debt instruments). Let us see how these strategies have played out.

We have considered popular funds in equal allocation from these three debt categories: 1) Credit risk funds (HDFC, Kotak, ICICI and SBI), 2) Corporate bond funds (HDFC, Kotak, ICICI and ABSL) and 3) Constant maturity gilt funds (ICICI and SBI).

In terms of a 3-year-daily rolling CAGR returns from 1 January 2018 to 28 February 2025, credit risk funds generated a 7% CAGR on average, an 8.8% CAGR at the maximum and 5.4% CAGR at the minimum, corporate bond funds at 7.3% CAGR on average, 9.2% CAGR at the maximum and 4.9% at the minimum and lastly constant maturity gilt funds at a 7.8% CAGR on average, 11.7% CAGR at the maximum and 3.2% CAGR at the minimum.