How interest rates affect mutual funds: debt funds, duration and equity

Interest rates reach your mutual funds in two ways. Debt funds feel them directly, because the prices of the bonds they hold move the opposite way to rates. Equity funds feel them more loosely, as one of many things that move share prices.

How do interest rates affect mutual funds?

Interest rates move a debt fund's value directly and an equity fund's value only loosely. Debt means loans: a debt fund buys bonds, which are loans to governments, banks or companies that pay interest. SEBI (the Securities and Exchange Board of India) says on its investor website: "When interest rates rise, bond prices may fall, and vice versa."

A fund's value moves with the prices of the bonds it holds. Each day, a fund's debt securities are priced at the average of the prices valuation agencies give. So the NAV, the price of one unit, can change every day.

The size of the move depends on the fund's duration, a measure tied to how long its bonds run. SEBI scores a longer duration as a higher interest-rate risk. That is the chance that a change in rates changes the value of the bonds a fund holds.

Equity funds, which hold shares, are different. AMFI, the mutual fund industry body, lists interest rates among many factors that may influence a fund's NAV.

If you searched for the interest rate a mutual fund pays, our SIP interest rate article answers that. Rates are one risk among several; see the risks involved in mutual funds.

What do RBI repo rate changes do to debt funds?

A repo rate change matters to a debt fund because it can shift market interest rates, and market rates set bond prices. RBI is the Reserve Bank of India. The repo rate is the rate at which it provides money to banks and other eligible participants against government and other approved securities.

A six-member monetary policy committee (MPC) decides it. In RBI's words, the MPC determines the policy repo rate required to achieve the inflation target. That target is 4% consumer price inflation, with a tolerance band of 2% to 6%. RBI wants a repo change to pass "through the entire financial system". For repo and reverse repo detail, see TREPS in mutual funds.

When market interest rates rise, the prices of bonds a fund already holds may fall, and when they drop, those prices may rise. AMFI says the same about a scheme's portfolio.

Two dated moves show how RBI has changed the rate. At an off-cycle meeting on 4 May 2022, the MPC unanimously raised the repo rate by 0.40 percentage points to 4.40%. On 5 December 2025 it cut the rate by 0.25 percentage points.

Why do bond prices fall when interest rates rise?

A bond's price is what its remaining payments are worth today at the market interest rate, so when market rates rise, the price falls. RBI says it directly: "If market interest rate levels rise, the price of a bond falls."

Take a made-up bond. Its face value, the amount repaid at the end, is ₹100. It pays a coupon, a fixed yearly interest, of ₹7. When the market rate (the bond market calls it the yield) is 7%, the bond is worth ₹100.

Now market rates move to 8%. New bonds pay more, so this one, stuck at ₹7 a year, is worth less. How much less depends on how many years it has left.

The 10-year bond loses ₹6.71 for a one-point rise, the 1-year bond only ₹0.93. The pattern matches what fund houses' scheme documents say: prices of long-term securities generally fluctuate more with interest rate changes than short-term ones. AMFI adds that the size of the move depends on the coupon and the maturity.

Falling rates have a catch too. AMFI points to re-investment risk: when rates fall, new interest and maturing money are reinvested at lower rates.

An NSE index tracking the 10-year government bond fell 11.73% between 27 May and 19 August 2013, as debt mutual funds vs fixed deposits notes. What bonds are has the basics.

Government securities (G-secs) are bonds issued by the government. RBI says they carry practically no risk of default. Their prices still move with interest rates, so a gilt fund's value can fall when rates rise.

What is duration, and why does it matter in a debt fund?

Duration is a number of years that shows how sensitive a bond's price is to interest rates. SEBI uses it to measure a debt fund's interest-rate risk. Two versions matter: Macaulay duration and modified duration.

Macaulay duration in plain words

Macaulay duration is the average time, in years, until you get a bond's payments back, weighted by what each payment is worth today. For a fund, SEBI takes the weighted average of each bond's figure, weighted by that bond's share of the fund's assets.

How SEBI uses duration

SEBI sorts every debt fund on the Potential Risk Class (PRC) matrix, its grid for debt schemes. The interest-rate side has three classes. Each sets the highest weighted average Macaulay duration a scheme may hold. Class I allows up to 1 year, Class II up to 3 years, and Class III any duration. A class is a ceiling, not a target.

The riskometer, SEBI's six-level risk label, also scores interest-rate risk using the portfolio's Macaulay duration. The score is 1 for up to 0.5 years and 2 for over 0.5 to 1. It is 3 for over 1 to 2, and 4 for over 2 to 3. It reaches 5 for over 3 to 4, and 6 for over 4 years.

SEBI also defines debt categories by duration. The first column below has SEBI's names, in use since 26 February 2026; the second has the names our category pages use.

The debt funds page has each category's rules.

Modified duration: the rough size of the move

Modified duration is a modified version of Macaulay duration that gives the rough size of the price move. RBI says modified duration is approximately the percentage change in price for a 1% change in yield. Fund houses' factsheets describe it the same way. The made-up 10-year bond above has a modified duration of 7.02. The rule of thumb says a 1% rise cuts its price by about 7%; the table shows 6.71%.

So treat the figure as an approximation, and remember that a fund's holdings keep changing.

Duration funds or hold-to-maturity funds: what is the difference?

Dynamic bond funds can change their duration, while target maturity funds hold only bonds that mature by a set end date. One dynamic fund's scheme document says the fund house will "strive to actively manage the duration". It does so based on market conditions and its outlook on interest rates.

Target maturity funds follow an index of bonds with an end date. SEBI's rule: no security in the portfolio may mature after that date. On the end date, the fund redeems everyone's units at that day's NAV and pays the money into your bank account. What you get is the value of the fund's bonds on that day, not a fixed amount promised in advance.

If you hold a bond to maturity, price swings in between do not matter. You get its interest and your money back, as long as the issuer pays. A fund is different because it keeps buying and selling, and you can sell at any time, so its NAV moves with rates.

Target maturity funds come closest to holding to maturity; most other debt funds do not. See target maturity funds and dynamic bond funds. Which of the two fits depends on your own time frame.

How do interest rates affect equity funds?

Interest rates affect equity funds through borrowing, spending and asset prices, with no fixed direction. When RBI changes the repo rate, banks' lending rates tend to follow. That changes what companies and households pay to borrow and how much they spend. It can feed through to company earnings and to share prices, but there is no fixed rule for which way markets move.

An article in the RBI Bulletin, in its authors' view, says policy rate changes also shift asset prices. For your fund, interest rates are one of many things that move an equity fund's NAV. See equity funds.

Rates are rising: what matters for your debt funds?

What matters is how your time frame compares with the fund's duration, its credit quality and when you need the money. When rates rise, the prices of bonds a debt fund already holds may fall, and a longer duration generally means a bigger move. Interest and maturing money are also reinvested at whatever rates then prevail.

The useful questions are about your own situation, not about where rates go next:

• Your time frame against the fund's duration. A long-duration fund can swing more than a short-duration one.
• The fund's credit quality. Rate risk is not the only risk; the riskometer and the PRC class show more.
• Whether you need the money soon. SEBI's investor website says selling before maturity can mean a loss.

Selling after a fall locks the fall in, and it has tax consequences. Under the Income-tax Act, 2025, gains on Specified Mutual Fund units acquired on or after 1 April 2023 are short-term capital gains. That holds however long you have owned the units, and they are taxed at your normal slab rate. A Specified Mutual Fund is one that invests more than 65% of total proceeds in debt and money market instruments. How SIP returns are taxed has the detail.

Koshex reviews your holdings over time and flags changes, such as a fund's category, risk or ranking shifting. Customers can redeem units, and switch between schemes of the same fund house, on Koshex.

For when selling makes sense, read when should you sell a mutual fund. For a monthly plan, see SIPs in a debt fund.