Four passive debt funds to invest right now

Not so long ago, if debt investors in India wanted to get a 7% plus return, they had to go to post office schemes with (poor service and) a long lock-in period like the PPF or GOI Floating Rate Savings Bonds with a 7-year lock-in period. These options, apart from the difficulty of accessing them, required investors to sacrifice liquidity for returns. 

But RBI’s recent off-cycle rate hike has put a 7% yield well within reach for debt mutual fund investors even without such lock-ins. In this call, we highlight a debt mutual category and specific funds within it, that can get you close to a 7% yield through the open-ended format, for a 5-year holding period.

Four passive debt funds to invest right now

Why enter now?

Our earlier article on the interest rate upcycle in India highlighted that market yields had been climbing even before RBI began its current cycle of pegging up interest rates. 

But RBI’s sudden off-cycle rate hike last week, has added a new urgency and ferocity to the rise in market yields. The table below shows just how much yields on g-secs have moved just in the last week to 10 days. When bond yields get going, it is the benchmark 10-year g-sec that hogs most of the market attention. Sharp moves in g-secs of lower maturity tend to flow under the radar. This has been happening recently too, with the sharp up moves in the 3 year and 5-year g-sec going largely unnoticed.

With the 5-year g-sec seeing its yields move up past 7.2%, we think this is a good time for investors in debt mutual funds to lock into target maturity funds that invest in g-secs and SDLs with a 5-year tenure now (Learn all about target maturity funds here). SDLs, which are State government borrowings, usually offer 40-50 basis points higher yield than Central government securities without materially higher risk.

Why five-year?

There are four reasons why we are recommending gilt/SDL target maturity funds with a 5-year (2027) maturity right now:

#1 Low term premium:

The decision on whether you should go in for bonds of longer tenor or shorter ones should depend on the term premium- the extra yield you get to lock in your money for a longer period. Today India’s term premiums for 10-year g-secs, over 5 years, are quite low. While the 10-year g-sec is offering a yield of 7.3%, the 5-year g-sec is at 7.1%. That’s only a 20-basis point addition return for stretching your tenure by 5 years. In the last three years, the term spread between the 5 and 10-year gilt has averaged 50 basis points, sometimes going as high as 75-80 basis points. 

A good way to capitalise on this opportunity is to buy target maturity debt funds investing in g-secs, SDLs or PSU bonds or a combination of these, set to mature in 2027.

# 2 Anytime liquidity:

Target maturity funds should be ideally held for investment horizons or goals that match with the fund’s maturity date to obtain the expected yield. But in case you happen to need your capital for an emergency before the maturity date, they do offer liquidity as they are structured as open-end funds. When you buy g-secs directly, they are hard to liquidate mid-term via the secondary markets as liquidity tends to be patchy.

#3 Lower rate risk:

We think there’s still considerable room for market yields to rise from here. Such increases will lead to mark-to-market losses for investors who buy into debt funds now. But longer the maturity, higher these losses. Therefore, a 3 or 5-year g-sec or fund offers better protection against MTM losses than 10 year g-secs, should some emergency needs crop up, requiring you to exit your fund before the maturity date.

Target maturity funds also follow a roll-down strategy, which reduces the investor’s rate risk if she matches her own holding period with the fund’s. (Want to know what’s roll-down? Read this:

#4 Very tax-efficient:

Though buying into g-secs of 5-year maturity whenever primary auctions crop up on RBI Retail Direct is the safest way to play this yield opportunity, this route is tax inefficient, especially for those who don’t need regular income or are in the higher tax bracket. 

G-secs offer investors only a payout option in which the coupon is paid out half-yearly. The interest gets taxed at your income tax slab rate. Debt mutual funds however offer long term capital gains taxation if held for over 3 years. Your final NAV returns from 5-year target maturity funds will suffer low tax incidence, because your accumulated capital gains are liable to 20% tax only after adjusting for inflation indexation on your purchase costs. With inflation ruling quite high now, you may get away with very low tax on your final returns on such funds, if you hang on till maturity. 

Please note that debt fund taxation has undergone a change. Indexation benefit will not be available for investments made from April 1, 2023 onwards. You can read about this in our article, ‘Tax changes in mutual funds: How to manage your investments now‘.

On many of the above factors, Target Maturity Funds score over bank FDs as well as post office schemes of comparable maturity. 

When choosing target maturity funds right now, we looked for five factors: 

  • The fund invests only in Central g-secs or SDLs with 5-year maturity and not PSU or corporate bonds. This is because we believe corporate bond yields are yet to move up to levels where they offer a good risk premium over sovereign bonds.  
  • The funds should be from AMCs that have a good reputation in debt fund management and are free of controversies. 
  • The funds should have low expense ratios (TERs) on their direct plan. 
  • The funds’ portfolios should have over 95% exposure to gilts or SDLs that mature in 2027, with low money market or other exposures. 
  • The funds should manage a reasonable asset size.

Which funds?

These filters led us to the following recommendations: 

  • IDFC Gilt 2027 Index Fund: An open-end index fund that offers a pure-play exposure to Central g-secs, this fund tracks the CRISIL Gilt 2027 Index and manages assets of Rs 2841 crore with a average Direct Plan TER of 0.16%. Over 95% of its portfolio was invested in two Central g-secs maturing in May 2027, with the remaining invested in treasury bills. 
  • ICICI Pru Nifty SDL Sep 2027 Index Fund: An open-end index fund that tracks the Nifty SDL April 2027 index, this fund had 96% of its portfolio invested in SDLs from 19 States. States such as Tamilnadu, Madhya Pradesh, Chattisgarh, Punjab, Gujarat, Rajasthan top its exposures. As of April 30 2022, it had an average portfolio maturity of 4.5 years. The fund’s average Direct plan TER is 0.15% and it manages Rs 399 crore. 
  • Aditya Birla Sun Life Nifty SDL April 2027 Index Fund: A well-diversified fund mirroring the Nifty SDL April 2027 index, with over 97% SDL exposure, it owns Gujarat, Telangana, UP, Rajasthan, Maharashtra, Gujarat SDLs as its top holdings in a portfolio of 47 securities. Its average maturity was 4.5 years by end April 2022. Its average Direct plan TER is 0.16% and it manages Rs 1793 crore. 
  • Kotak Nifty SDL Top 12 Equal Weight Index Fund: This fund, which tracks the Nifty SDL April 2027 Equal Weight Index, has over a 95% allocation to the most liquid SDLs at the time of its launch. Though the index started out with equal weights in its holdings, the fund’s latest portfolio features weights in SDLs ranging from 4% to 9%, with the top SDLs being Rajasthan, Gujarat, Kerala, West Bengal, AP and Bihar. It manages Rs 928 crore and has an average Direct plan TER of 0.15%.  

Though they offer pure-play exposure to Central g-secs, we are wary of recommending Nippon 5-year Gilt ETF or Motilal Oswal 5-year G-sec ETF at this stage because of their sub Rs 100 crore assets and their liquidity and trading volumes in the secondary markets tend to be patchy. Of the two, the latter appears to have better trading volumes and may be worth watching.  

For those looking for income generation, G-Secs and SDLs are great options and can even be a better fit than the funds mentioned above. Please check our Prime Bonds options for our current recommendations.

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60 thoughts on “Four passive debt funds to invest right now”

  1. A quick Q here if I may. Have come on board newly and like the diligence in your reports- much appreciated.
    Where can I find current or latest (say a couple of days’) YTM for the Target Maturity funds – preferably at one place without having to go through individual fund houses.
    Thanks in advance

    1. AMCs update portfolio details such as YTM only on a monthly basis. Some may update current/latest YTMs for their target maturity funds, but if they do so, it would typically be on their websites only. – thanks, Bhavana

  2. Just a question on the way these funds operate. I understand that these are open ended funds, but all their investments mature by 2027 (for example : ICICI Pru Nifty SDL Sep 2027 Index Fund has a maturity of 4.5 yrs). Will the fund gets closed by 2027 and money returned or the fund will continue to operate and we should on our own redeem by 2027 to be in sync with our investment duration and return expectations

  3. Hi, thanks for a great article. Few queries:
    1) can we do lumpsum investment in these funds now?
    2) RBI raised interest rate yesterday, there could be few more coming. What would you advice – should I do investment in staggered way over next few months


    1. Markets tend to move ahead of RBI actions. Recently rates have fallen a bit from the time we wrote this. However you can invest lumpsums still and get a 7% plus return..staggered investments may not work as well

    1. The answer depends on when you need the money. If you need it only after ten years, by going for constant maturity, you’d avoid the need to reinvest the money after 4-5 years

  4. Thanks for the article! I have query on Bharat Bond April 2025 Index fund- I invested last year around same time..My current gains are just around 2 PC? When I invested YTM was around 6 pc, if I have understood passive debt funds and YTM correctly, I should still expect to get 6 pc return if I hold till maturity? Please help me here!

  5. To clarify, these index fund recommendations are for holding for 5+ years with a target return of 7%?

    1. Bhavana Acharya

      No, being target maturity funds, they will mature in 2027. So you will have to reinvest if you do not require the proceeds to meet any goal – thanks, Bhavana

  6. Kiran Bhansali

    All the four funds recommended here have run up in the last one month. Would it be prudent to make a lumpsum investment at this point of time?

  7. There are passive debt funds that invest in PSU Bonds and SDL with similar maturities of the above mentioned passive debt funds. I would like to have your views on them. A couple of them are Aditya Birla Sun Life Nifty SDL Plus PSU Bond Sep 2026 60:40 Index Fund – Direct Plan YTM 7.42% & ICICI Prudential Nifty PSU Bond Plus SDL Sep 2027 40:60 Index Fund- Direct Plan YTM 7.43%.

    1. I left them out because PSU bond yields are not as attractive as SDL yields. I expect the PSU yields to rise more, presenting a better time to invest.

  8. You mentioned that with upcoming rate hikes there may be MTM losses ( I heard that on the live session today as well). Hasn’t the bond market factored in the upcoming rate hikes ( I believe it is well communicated by RBI)? What is your view ?

    1. Our current view is that the prospect of global recession could curb rate hikes after the initial burst. In India, there could be some upside left in yields, we think the 10 year could hit 7.75-8% by year end. It would be tough to time investments to the top of the rate cycle. But at this point we feel the prospect of higher accruals outweighs the temporary risk of MTM losses

  9. Hi

    I have PI recommended corporate bond (Kotak, Birla, HDFC) and banking/psu (Axis, IDFC) bond funds in my “general 4 year + medium to long term portfolio”. They will finish 3 years soon. If I dont need money for 5 more years, should I leave them undisturbed or move to funds mentioned in this article?


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