Heightened geopolitical tensions, on the rise crude oil priceand the uncertainty around interest rate cycle are reshaping the investment landscape, prompting a renewed focus on stability within portfolios.
In an interaction with Kshitij Anand of ETMarkets, Devang ShahHead – Fixed income has Ax Mutual Fundsaid the current environment strengthens the case for fixed income as a core allocation.
As rate cut cycle nears end and volatility expected to persist, he warns investors remain cautious over time and prefer high-quality short-term debt strategies that can provide steady accumulation and resilience to evolving macroeconomic risks. Edited extracts –
Kshitij Anand: As global markets face heightened geopolitical tensions, ranging from ongoing conflicts to trade uncertainties, how are these risks reshaping investor interest in fixed income assets at present?
Indian Bank to launch infrastructure debt issue of over $500 million next week, says MD
The Indian bank is raising 50 billion rupees in seven-year infrastructure bonds next week. The move aims to finance stronger credit growth and capital requirements. The bank is seeking longer-term funding as deposit rates have risen. Discussions with investors such as the Employee Provident Fund Organization are ongoing. This issue marks the bank’s return to the bond market after more than 17 months.
Devang Shah: As you rightly pointed out, first of all, it is important from every investor’s perspective to always have an asset allocation. What I mean by disciplined asset allocation is that you shouldn’t put all your money in one asset class.
We have done a few studies (this is also part of our multi-asset allocation theme) where we analyze the top six or seven asset classes that investors typically consider, such as precious metals, bonds, stocks, global assets and offshore assets. Specifically, if you look at offshore assets like the US and Chinese markets, and analyze the performance of these assets over different time periods, our 20-year study clearly shows that there is no single winner. No asset class consistently outperforms others or offers superior returns at all times.
Asset allocation therefore becomes an even more important topic in the future. Fixed income securities play a crucial role in this regard as they provide stability. Historically, with the exception of periods like 2008, 2013 and part of 2018, fixed income securities have generally not generated negative returns. Thus, it also offers some capital protection.
In the current environment, investors should certainly have some allocation to fixed income. The exact allocation depends on several factors, such as the macroeconomic outlook, central bank actions, inflation, growth, the rate cycle and liquidity. These are important levers to consider when choosing allocation to fixed income.
Given the current environment – characterized by increased volatility due to geopolitical uncertainties and rising crude prices – bonds are certainly good reasons.
Kshitij Anand: For much of last year, markets priced in rate cuts from major central banks. But what happens if the rate cut cycle is delayed or does not materialize as planned? How should investors rethink their bond allocation in such scenarios?
Devang Shah: You are right: the last two years have been very positive for the bond markets. In developed markets and India, central banks have cut rates, leading to a strong cycle of rate cuts globally.
However, since June, at Axis we have been communicating that we are approaching the end of this pricing cycle. Going forward, other levers will drive fixed income returns. We believe we are near the end of the rate cycle and do not expect significant rate cuts in the future.
Today, with the current geopolitical tensions and the sharp rise in crude prices, we need to look at two key aspects: how long this situation will last and where crude prices will stabilize in the short to medium term.
In our view, while no one can predict geopolitical developments with certainty, markets will eventually realign to a new crude price range in terms of inflation, growth, corporate profits and budget deficits.
We believe that if crude prices remain in the $75-$85 range, the impact on the Indian economy will be present but muted. This will not significantly deteriorate macroeconomic conditions and will not force the RBI to raise rates immediately.
There could, however, be some impact: inflation could increase by around 0.5%, from around 4.5% to 5%. Growth could slow slightly from the 7% and above expected, and the current account deficit could widen by around 1% to 1.5-1.75%.
This means that although macroeconomic fundamentals may weaken slightly, they will remain broadly stable. In such a scenario, the RBI should continue to support growth by ensuring adequate liquidity. Although inflation is a short-term concern, the bigger medium-term risk is a slowdown in growth if crude prices remain high.
We therefore do not expect significant tensions on bonds. Bond yields have already adjusted, particularly at the short end of the curve, which has seen a sell-off of around 30-50 basis points. OIS also increased by around 30 basis points.
If crude prices stabilize between $75 and $85, we do not expect any further impact. However, if crude prices rise above $100 – which we view as a lower probability but still a risk – it could trigger a faster rate-rising cycle, pushing bond yields higher across the curve.
In such a scenario, it would make sense for investors to remain positioned on the short end of the yield curve.
Kshitij Anand: Today, in a world where stocks can generate high wealth creation but also high volatility, how can bonds help investors balance growth, income stability and capital preservation within a portfolio?
Devang Shah: As you rightly point out, we live in a world of uncertainty today, and this uncertainty will continue to prevail. This is why asset allocation is becoming more and more important.
In today’s market environment, where much of the rate cycle has ended and we are at a point where the next step could be a rate hike, whether in six or twelve months, the key question is how to navigate this environment without experiencing significant volatility in your debt portfolio.
So, what should an investor do? This is the most important question. My understanding is that, as I mentioned earlier, the shorter end of the curve – down to the one to three year segment – has seen a massive sell-off over the last six to nine months.
Let me share some numbers. One-year CDs were trading between 6.25 and 6.30% in June 2025. Today, despite rate cuts over the past nine months, they are trading in a range of 7 to 7.25%. This implies a sell-off of around 50-75 basis points. This is largely due to strong credit growth and a degree of foreign exchange intervention, which led to a temporary liquidity crunch.
Similarly, three-year corporate bonds, which were trading around 6.5%, are now closer to 7.25-7.30%.
So, our view is that the segment which has already seen a sell-off – and which is unlikely to react sharply even if the RBI starts raising rates – is the one investors should focus on in the short term, say over the next 12-18 months.
With yields of 7-7.25%, money market strategies and conservative short-term funds make a lot of sense for investors who want to navigate this uncertain environment, influenced by crude price volatility, political uncertainty and macroeconomic risks if crude holds above $100.
Kshitij Anand: Also, as we approach the end of the financial year, can you summarize how FY26 went for the bond markets in general?
Devang Shah: FY26 was a volatile year. This started with significant policy easing, liquidity support and rate cuts through June. As I mentioned earlier, rates were cut by 50 basis points in June.
So the year started on a strongly positive note for bonds, but then some of those gains were given up. If you look at the 12-18 month returns, they’re still pretty healthy. At one point, bond markets were generating returns close to double digits: by June 2025, most debt funds, whether short-term, medium-term, long-term or gilts, were posting double-digit returns.
However, some of these gains have been eroded due to global uncertainties, rising crude prices, large supply of government development loans and strong credit growth, indicating that we are nearing the end of the rate cycle.
Overall, FY26 was mixed for the bond markets. The extremely short segment performed very well. Short- and medium-term funds generated reasonable returns, while long-term bonds remained volatile.
Kshitij Anand: As the financial year draws to a close, how should investors review their portfolios? Are there any specific adjustments they should consider in fixed income allocation before the start of the new financial year?
Devang Shah: Our assessment is based on the assumption that over the next two to three months conditions will stabilize and crude prices are unlikely to remain above $100 for an extended period.
In this baseline scenario, we advise investors to reduce the duration of their bond portfolios and focus on the short end of the curve.
Specifically, money market funds, short-term conservative funds, and a relatively new category – income and arbitrage funds of funds – are attractive options. These funds, with an investment horizon of two years, can generate returns similar to those of debt securities with taxation similar to that of stocks.
Even in a less likely scenario – say a 20% probability – where crude remains above $100 and causes significant pressure on growth, investors should continue to invest in the short end of the curve in the near term. Indeed, the first reaction would probably be a change in central bank policy towards an increase in rates.
Once this scenario materializes, opportunities could emerge during the second half of the year to allocate to longer duration funds.
For now, the main portfolio adjustment should be to reduce duration, focus on money market strategies, short-term conservative funds, and income and arbitrage funds of funds. However, for income and arbitrage funds, investors must maintain an investment horizon of at least two years to fully benefit from tax efficiency.
Going forward, depending on the macroeconomic environment, tactical opportunities may emerge in long-duration bonds.
Kshitij Anand: So, what should investors keep in mind while strategizing a bond strategy for the next financial year amid global uncertainty and changing interest rate expectations?
Devang Shah: The general fear, when such uncertainties increase, is that investors will tend to turn to highly liquid funds. They prefer instruments that offer high liquidity and are relatively insensitive to risks such as duration volatility and potential growth slowdowns.
Our view at this point is that if you want to navigate this environment effectively, you should stay invested in funds that hold primarily AAA-rated credits, have a strong quality bias, and avoid taking excessive exposure to duration, as duration can introduce volatility.
If growth weakens, then the credit cycle could start to deteriorate with some lag. While this is not our baseline scenario, investors who want to take a more conservative approach should continue to look to money market funds, low sensitivity strategies, and ultra-conservative short-term bond funds, with a strong emphasis on high-quality AAA issuers.
That said, the credit cycle remains strong today. I don’t see any immediate concerns. India’s macroeconomic situation has not weakened significantly and the credit environment remains healthy. If you look at NPAs of banks and NBFCs, debt levels and profitability, there has been no significant deterioration.
However, as a word of caution, if crude prices continue to hover around $100 or more, it could slow India’s growth and create future concerns. To deal with such a scenario, it is best to stay invested in money market strategies with an investment grade bias.
Kshitij Anand: What factors are accelerating retail participation in India’s traditionally institutional bond markets, and what more needs to be done to deepen this ecosystem?
Devang Shah: For starters, regulators have done a commendable job. Today, retail investors have access to government bonds via dedicated platforms, which was not the case before. Regulators have also simplified many aspects to help investors better understand the products they are investing in.
Mutual funds have also played an important role. Today, there is a fund for every investor need. If you want to invest for a day, there are overnight funds. For three months there is liquidity. For longer time horizons, there are target date funds, index funds or long duration funds.
SEBI and RBI have done a great job in promoting investor education. Tools such as risk indicators and portfolio disclosure matrices help investors understand the risk profile and credit quality of their investments, including exposure to non-AAA assets.
Many improvements have been made since the credit crisis of 2018. Today, mutual fund products are much easier for retail investors to understand.
Innovations such as direct participation in government bonds and ensuring liquidity through mutual fund structures are important steps towards deepening the corporate bond market. These developments will encourage increased retail participation in fixed income securities in the medium term.
Kshitij Anand: Finally, Indian government bonds have started to be included in major global indices. How might this influence foreign capital flows, yields and investor interest in the Indian bond market?
Devang Shah: In my view, the increasing depth of the Indian bond market – reflected in volumes, bid-ask spreads and overall size – has made it more attractive to global investors.
We have already seen early steps with JPMorgan including Indian bonds in its indices, followed by partial inclusion in some Bloomberg emerging markets indices. There is also a good chance that Indian bonds will be included in the Bloomberg Global Aggregate Index, which tracks a market between $2.5 trillion and $2.8 trillion.
If this happens, India could see an allocation close to 1%, potentially generating $20-25 billion in inflows. We think this could happen over the next 12 months, perhaps as early as the June review.
Such inclusion could create tactical opportunities in long-duration bonds, as inflows could lead to a recovery in this segment depending on prevailing yield levels.
However, in the current environment, investors should maintain a higher allocation to the short end of the curve due to uncertainties surrounding crude prices, geopolitical risks and the fact that the rate cut cycle is largely behind us.
In a stable or rising rate environment, it is prudent to focus on accrual or carry strategies through short-duration funds.
That said, inclusion in the global index is a huge benefit. As the Indian bond market continues to grow in depth and scale, new such opportunities are likely to emerge, creating new opportunities for investors over time.
(Disclaimer: The recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)