When interest rates rise, existing bonds become less valuable and most debt fund NAVs fall. When rates fall, those same bonds are worth more and debt fund NAVs typically rise. Equity funds, on the other hand, feel the impact through valuations and earnings expectations: higher interest rates compress P/E multiples and raise discount rates; lower rates do the opposite.
Your results depend on what you own (duration, credit mix, sector tilt) and how long you’re holding.
Debt funds: why NAVs move when the RBI moves
Bond prices and yields move in opposite directions. If your fund holds bonds with a Macaulay duration of 4 years and market yields jump 0.50%, a rough price hit is about 2% (modified duration × yield change, ignoring convexity). That math is baked into every debt fund. Accrual (the portfolio’s yield to maturity minus expenses) adds value daily, but mark-to-market changes can dominate over short periods when rates swing.
Know your category before you react
Liquid and overnight funds carry tiny duration. Thus, rate changes barely dent their NAVs; yields reset quickly as holdings roll.
Ultra-short/low duration funds feel a little more impact but stay relatively stable.
Short duration and corporate bond funds sit in the middle.
Gilt funds and long duration funds swing the most, because they hold longer-maturity bonds that are far more sensitive to rate changes.
Credit risk funds add a separate driver—credit spreads—so they can rise or fall for reasons unrelated to the RBI, including downgrades.
Yield curve shifts matter as much as the headline repo
The curve doesn’t always move in lockstep. It can steepen (long yields rise more than short), flatten (longs move less than shorts), or twist. A long duration gilt fund bleeds when the long end sells off even if the repo rate is unchanged. Conversely, if the market starts pricing future cuts at the long end, long duration funds rally before any official announcement.
These shifts often reflect market expectations––inflation, growth, policy outlook––rather than only the move in interest rate. Your fund’s average maturity and duration tell you which part of the curve you’re exposed to.
Rising rates playbook
If you expect rates to climb, shorten duration. Liquid, ultra-short, and low duration funds keep NAV volatility low while their portfolio yields reset upward as securities mature.
Floating-rate funds can help because coupons move with benchmarks, dampening price hits.
If you need to own longer bonds (say for ALM or asset/liability management reasons), consider staggering entries instead of going all-in at one yield print.
In credit-heavy funds, rising rates can stress weaker issuers, so favour higher quality over chasing a tempting YTM (yield-to-maturity).
Falling rates playbook
If the cycle is turning down, longer duration benefits most.
Gilt and long duration funds typically front-run the cuts as markets discount easier policy.
Target maturity funds can also shine: as yields fall, both price appreciation and the roll-down effect (bonds getting closer to maturity) lift returns.
The caveat is obvious. If the rally is already crowded and yields are close to your return hurdle, the remaining upside may not justify the extra volatility.
Target maturity funds
These passive portfolios buy a basket of bonds maturing in a specific year and hold to maturity. Your return path comes from the starting yield, minus costs, plus any interim price moves as the bonds roll down the curve.
Interest-rate risk shrinks as maturity approaches. If you match your investment horizon to the fund’s maturity, your outcome depends more on starting YTM and less on short-term rate noise. If you exit early, you’re exposed to the same price risk as any other debt fund.
Credit versus duration
Duration risk is about rates. Credit risk is about an issuer’s ability to pay. A rate cut can still coincide with a credit event that hurts a credit fund. If you’re earning a high YTM because the portfolio owns lower-rated paper, understand that spread widening can erase months of accrual in a week.
For most investors, it’s cleaner to take duration risk in high-quality portfolios and leave credit to a small, deliberate slice if at all.
Equity funds
When rates rise, the discount rate in DCFs (discounted cash flows) rises and P/E multiples compress, hitting long-duration equities (high-growth, profit-later stories) harder than cash-rich or defensive sectors. Financials can initially benefit from rising rates if net interest margins expand, but funding costs and credit cycles catch up later. Falling rates support higher multiples and ease financing, which helps rate-sensitive sectors like autos, real estate ancillaries, and consumer durables. This transmission is messy and lagged, but over full cycles, the sign is consistent.
Hybrids, arbitrage, and international exposure
Aggressive or balanced hybrids cushion equity drawdowns with debt, but the debt sleeve still moves with rates. Arbitrage funds behave more like liquid funds plus a small carry from cash-futures spreads; rate moves show up via short-term yields, not bond price swings.
International funds add currency to the mix. If global rates fall faster than India’s, foreign equity multiples can reflate, while USD/INR moves can either amplify or mute your rupee returns.
SIPs and STPs
Don’t stop SIPs in equities because rates are rising; you want more units when valuations compress. In debt, a Systematic Transfer Plan from liquid to a long duration fund can be suitable when you expect cuts but want to average the entry risk.
If rates are likely to rise, reverse that logic: park in liquid/ultra-short and move gradually into longer debt only after yields improve to your hurdle.
Conclusion
Interest rates change the speed of compounding in every sleeve of your portfolio. When they rise, consider shortening duration in debt, keep buying equities steadily, and insist on quality over yield. When they fall, take measured duration exposure, don’t overreach for late gains, and let valuation support work in equities. Match horizon to product, keep costs down, and make changes by rule—not mood. That is how you turn rate cycles into an ally instead of a surprise.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
