How should investors tackle volatile bond yields?

Despite the Reserve Bank of India’s rate cut in early December, bond yields in India moved higher, catching fixed-income mutual fund investors off guard.

WHAT ARE BOND YIELDS?
A bond yield is the annual return an investor earns on a bond, expressed as a percentage. While the coupon or interest rate on a bond is fixed, the yield fluctuates because it depends on the price you pay for the bond in the market. Bond yields and prices move in opposite directions— when prices fall, yields rise, and vice versa

WHAT ARE THE TRIGGERS FOR BOND YIELD MOVEMENTS, AND HOW DO THEY RESPOND?

Bond yields respond to a mix of macroeconomic and market factors. The most direct trigger is interest rate changes by the central bank. When policy rates are increased, yields move up, and when rates are cut, yields tend to decline. Inflation expectations also play a big role. This is because expected inflation pushes yields higher as investors demand more return to offset purchasing power erosion. Fiscal policy matters too: large government borrowing increases bond supply, which can depress prices and lift yields

WHY DID BOND YIELDS RISE DESPITE THE RBI’S RATE CUT IN DECEMBER?
Yield on the benchmark 10-year government security climbed from 6.5% on December 2 to 6.7% on December 23, before easing slightly to 6.63% on January 13. This was unexpected after the RBI lowered the repo rate by 25 basis points in early December. Analysts attribute the spike to a surge in bond supply. Indian states announced a record borrowing plan of `5 lakh crore for the January-March quarter. The oversupply pushed bond prices down, lifting yields. Foreign portfolio investors have also been selling Indian bonds amid pressure on the rupee. Additionally, markets are forward-looking. Yields fell through 2025 on expectations of rate cuts. With the RBI delivering a cumulative 125 basis points reduction, that optimism is priced in.

WHAT HAPPENS TO DEBT MUTUAL FUNDS WHEN YIELDS RISE?
Debt funds that invest in long term bonds feel the impact more of rising yields because their portfolios hold securities with longer maturities. Long-term bond funds don’t simply hold bonds to maturity for coupon income. They actively manage portfolios to benefit from price movements. When yields fall, the price of long term bonds rises sharply because these bonds have higher duration and are more sensitive to interest rate changes. Fund managers often sell such bonds before maturity to lock in capital gains. This is why long-duration funds typically deliver strong gains in a rate-cut environment. Short-term debt funds are less affected because their bonds typically mature within a year. Short-term funds tend to remain relatively stable and can even benefit sooner from rising yields.

HOW CAN DEBT MUTUAL FUND INVESTORS OPTIMISE RETURNS NOW?
In 2025, investors in longterm bond funds made money because bond prices rose and investors made capital gains. Along with interest income, investors earned high single-digit or double-digit returns, which are not often achieved. Now, wealth managers recommend a barbell strategy: roughly half in short-term funds (1 day-24 months) to capture current high yields and maintain liquidity, 30-40% in medium-term funds (2-5 years), and 10-20% in long duration gilt funds (above 5 years) to capture capital appreciation if yields soften after the recent spike