Why bond fund prices fall when yields rise

The seesaw

Bond prices and bond yields move in opposite directions. Everything else in a debt fund's behaviour, from a gilt fund's wild year to a liquid fund's flat line, follows from that one relationship.

Here is the plain reason. Suppose you buy a bond that pays a fixed 7% a year. The next month interest rates rise, and new bonds pay 8%. Nobody will pay full price for your 7% bond when 8% is on offer, so the price of your bond falls until a buyer would earn 8% on it. The coupon did not change; the price did. When rates fall, the reverse happens, and your 7% bond becomes more valuable.

A debt fund holds hundreds of such bonds, and its NAV is their market value each day. So a fund's NAV can fall even when nothing has gone wrong with any issuer. The guide on how mutual funds make money shows where this fits.

A worked example

Take a ₹100 face-value bond paying a 7% annual coupon, priced at ₹100 when the market yield is also 7%. Now see what its price becomes if the market yield moves one percentage point, for different maturities. (Our calculation, standard bond arithmetic; try your own in the bond yield calculator.)

Two lessons are in the table. First, the longer the bond, the bigger the swing, because a below-market coupon costs you for more years. Second, the swing is slightly bigger on the way up than on the way down, a feature called convexity that favours bondholders a little. The 10-year bond loses 6.7% when yields rise a point and gains 7.4% when they fall a point.

Duration: the rule of thumb

Duration packages this into one number. Modified duration is roughly the percentage change in price for a one percentage point change in yield. The 5-year bond above has a modified duration of about 4.1, which matches its roughly 4% move. For a debt fund, the factsheet reports the portfolio's duration, so you can estimate its exposure:

• Modified duration 0.1 (an overnight or liquid fund): a one-point rise in yields moves the NAV by about 0.1%. Almost nothing.
• Modified duration 2 (a short-duration fund): about 2%.
• Modified duration 5 (a medium-to-long fund): about 5%.
• Modified duration 8 or more (a long-duration or gilt fund): 8% or more, in either direction.

That is why SEBI sorts debt categories by duration, and why the debt fund duration ladder is the best single picture of the product range. For a longer look at the categories, see debt funds explained.

Interest income cushions the fall

The picture above is only the price effect. A bond fund also earns carry: the interest its bonds pay, reflected in the fund's yield to maturity. Say a fund has a YTM of 7.5% and a duration of 4. Yields rise by 1 percentage point, so the price falls about 4%. But the fund is earning 7.5% a year in interest, so the loss is made up in roughly 0.5 years of carry (4 divided by 7.5), and after that the fund is earning at the new, higher yield.

That is the basis of a common guideline: hold a debt fund for at least as long as its duration. A fund with a duration of 4 years is designed for a holding period around 4 years or more, because over that time a rise in yields becomes a benefit as the portfolio reinvests at higher rates. If you need the money sooner, pick a fund with a shorter duration. The checklist for choosing a debt fund turns this into a selection step, and the credit risk and YTM guide explains why a high yield alone is not enough.

What moves yields in India

Government bond yields respond to several things:

• The RBI's policy rate and its stance. The Reserve Bank of India sets the repo rate, and expectations of future changes move yields before the decision itself.
• Inflation. Higher expected inflation pushes yields up.
• Government borrowing and supply of bonds. Heavier borrowing can add to yields.
• Global yields and foreign flows, especially US Treasury yields and the rupee. See rupee vs major currencies.

No one forecasts these reliably, which is why a duration view is a bet and not a plan. If you want to see how the government bond market has behaved recently, the government bond index and gilt fund returns are written from the daily NAV data on this site, and the gilt fund category page lists the funds. For the fund type built to change duration with the cycle, read dynamic bond funds.

A practical way to use this

1. Match duration to the time you will hold. Money needed in a year belongs in funds with a duration under one. See emergency fund and liquid funds for the short end.
2. Do not buy a long-duration fund after a fall in yields just because its recent return looks great. A fund's recent return reflects past yield falls that cannot repeat at the same pace.
3. Check the duration on the factsheet every year, because a fund's duration drifts. A dynamic or medium fund can shift a lot.
4. Consider a target maturity fund if you want a fixed horizon; the price swings still happen along the way but the duration shrinks as the date nears. See target maturity funds.
5. Remember tax. Gains on debt funds bought on or after 1 April 2023 are taxed at slab rate whatever the holding period, as of October 2026, so a fund's post-tax carry is lower than its headline yield.

Where to see it in the data

Every debt fund's NAV is published daily by the fund house and collected by the Association of Mutual Funds in India at amfiindia.com. If you plot a long-duration fund's NAV against a liquid fund's, you will see the difference at once: one rises and falls with the yield cycle, the other creeps up almost in a straight line. The same dashboard idea is behind our compare tool, which charts funds from different categories on one axis, and the debt fund screens on this site. Looking at a fund's worst past fall from a peak is a good test of whether you could have lived through its duration risk, and that is a better test than a single year's return.

This post is for education only and is not investment, tax or financial advice. Bond prices, yields and tax rules change; illustrations use assumed figures and are not forecasts. Debt funds can lose value; verify before acting.