After three consecutive years of net outflows, debt funds witnessed a rebound in FY 2024-25, recording net inflows of ₹1.38 lakh crore, according to the AMFI Annual Report released in February 2025. This reversal was largely driven by an anticipation of interest rate cuts by the Reserve Bank of India (RBI), particularly after the repo rate was lowered to 6.25 per cent in February 2025, a factor that has increased the appeal of debt instruments. Amidst global developments like interest rate movements and global geopolitical risks, investors are now looking at instruments that offer both stability and liquidity. Among the options, debt funds and hybrid funds are emerging as key components of a balanced portfolio.
In an exclusive interaction with Livemint, Tejas Soman, Chief Investment Officer – Debt, at PPFAS Mutual Fund shared his views on the short-to-medium-term interest rate trajectory, the strategic role of liquid funds in a volatile environment and some essential considerations for investors as they choose between the different categories of debt and hybrid products. Some edited excerpts.
Q. What’s your view on the Indian debt market, and how do you see the interest rate trajectory shaping up in the short to medium term?
Mr Tejas Soman: In a significant policy move, the RBI frontloaded its rate easing with a 50-bps cut in June 2025, followed by a planned phased reduction of the Cash Reserve Ratio (CRR) by 100 bps. With much of the monetary easing already delivered, the RBI may have little room left for further intervention. Despite robust domestic fundamentals, global developments are now catching up with Indian bonds. With no clear progress on trade negotiations, tensions across the world are mounting. Over the past two years, Indian bonds were remarkably resilient amid global economic volatility. This strength was largely because of the RBI’s monetary approach and fiscal discipline by the central government. However, the global developments will now overweigh the interest trajectory than domestic fundamentals.
Q. What impact will geopolitical risks have on interest rates? Do you foresee any risks in the short-term that can impact yields?
Mr Tejas Soman: As I said earlier, the direction of domestic yields may now be increasingly shaped by global dynamics – including the path of global interest rates, trade tariffs impacts, and capital flow trends – rather than domestic inflation-growth dynamics alone. The central government’s measures in response to recent trade tariff announcements may put pressure on both central and state finances. This rising fiscal pressure is expected to be a key factor influencing the near-to-medium-term trajectory of interest rates. The interest rate curve has steepened in the recent months and is likely to remain elevated, supported by comfortable liquidity conditions and a benign inflation outlook. However, uncertainty on fiscal front may keep long-term bond yields high until there is greater clarity on global economic developments. Additionally, the Indian Rupee has weakened to a record low against the US Dollar, reflecting growing concerns over global uncertainty.
Q. With increasing market volatility, what role can liquid funds play in an investor’s portfolio, particularly for those with a short-term investment horizon?
Mr Tejas Soman: Liquid funds serve as an essential cash management tool, providing a short-term investment solution until better opportunities arise. They predominantly invest in high-quality money market instruments, which helps minimise interest rate and credit risk. Additionally, with zero exit load after 7 days, liquid funds play a crucial role in efficiently managing an investor’s cash needs.
Q. One of the uses is that liquid funds are put to use to park idle cash. What are some of the key advantages of liquid funds that investors tend to overlook?
Mr Tejas Soman: The quick access to funds supports operational flexibility and contingency planning – for example, serving as an emergency fund for retail investors. We also offer an instant redemption facility of up to ₹50,000 or 90 per cent of your investments, whichever is lower. For corporations, liquid funds present a credible alternative to keeping money idle in current accounts, allowing short-term investments that earn returns instead of zero interest income.
Q. How do liquid funds manage credit risk, and what measures does your fund house take to ensure the safety and liquidity of these investments?
Mr Tejas Soman: With our risk-oriented philosophy, we view liquid funds as a strategic tool for capital preservation and cash management, not return optimisation. We invest only in AAA-rated instruments and sovereign securities, ensuring minimal credit and interest rate risk. These instruments provide us with the liquidity and predictability needed to manage short-term obligations and unforeseen requirements.
Q. For investors looking for a balance between growth and stability, what are the key differences between debt and hybrid funds, and how should they decide which is right for them?
Mr Tejas Soman: There are two important factors that investors should consider. The first is taxation. It is crucial to consider the tax implications of different investments, especially for individuals in higher tax brackets. Debt funds are taxed at the investor’s marginal tax rate, which can significantly impact net returns for those in higher income slabs. In contrast, hybrid funds where equity allocation is more than 35 per cent, offer more favourable tax treatment through long-term capital gains taxation, which can be advantageous over the long term.
The second factor is Asset Allocation. Many investors tend to have substantial exposure to debt through instruments like PPF, FDs, or EPF. Adding pure debt funds to such a portfolio may dilute long-term real (adjusted for inflation) returns. This is where hybrid funds offer a strategic advantage. Dynamic Asset Allocation Funds provide a balanced approach by allocating to both equity and debt. The debt portion adds stability, while the equity allocation drives potential growth. At PPFAS, we follow a conservative approach in managing our Dynamic Asset Allocation Fund, maintaining an unhedged equity exposure of approximately 15–20 per cent of the portfolio. These will be largely cash-flow yielding securities, either distributing cash through dividends or sometimes special payouts.
Q. What are the various types of debt funds available and how do investors decide which one is best suited for you?
Mr Tejas Soman: A lot depends on the investor’s time horizon. If the goal is short-term cash management, options like Liquid Funds or Money Market Funds are more suitable. However, for longer investment horizons – typically beyond two years – debt-oriented hybrid funds can serve as a compelling alternative, offering a balanced approach with potential for better returns and moderate risk.
Q. Could you elaborate on the concept of ‘mark to market’ for debt funds and explain how it impacts an investor’s returns, especially during periods of market stress?
Mr Tejas Soman: The Net Asset Value (NAV) of a debt fund reflects the real-time market price of the bonds or instruments it holds – not just their interest income. Debt securities (like government bonds, corporate bonds, etc.) fluctuate in price due to two major factors: interest rate risk and credit risk.
An increase in interest rates leads to a decline in bond prices, while a decrease in interest rates results in a rise in bond prices. These price movements lead to mark-to-market (MTM) losses or gains in the underlying securities, respectively. In addition to interest rate movements, the credit quality of the bond issuer also plays a crucial role in pricing. If a company’s credit profile deteriorates, investors demand a higher return for the increased risk – known as a widening of credit spreads. As a result, the price of that company’s bond falls to compensate for the added risk.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
Disclaimer: The views and opinions expressed in this communication are solely of Mr. Tejas Soman, and do not necessarily reflect the official policy or position of PPFAS Mutual Fund, and not of Mint. Any content provided is for informational purposes only and should not be interpreted as professional or organizational advice. We advise investors to check with certified experts before making any investment decisions.