India's open-ended debt mutual funds experienced a significant reversal in investor sentiment in May 2025, recording net outflows of ₹15,908 crore, according to data released by the Association of Mutual Funds in India (AMFI). This downturn came after strong inflows of ₹2.19 lakh crore in April 2025, highlighting the short-term volatility and shifting preferences within fixed-income investments.

The outflows were mainly driven by redemptions in the liquid and overnight fund categories, both of which are popular with institutional investors for short-term parking of funds.

Liquid and Overnight Funds Face Heavy Redemption

The liquid fund category, which allows high liquidity and low duration investment, saw outflows of ₹39,725 crore in May. Similarly, overnight funds recorded ₹8,600 crore in net redemptions.

These two categories are heavily influenced by institutional treasury movements and liquidity requirements, making them more sensitive to end-of-quarter and regulatory considerations.

“Short-term liquidity needs and treasury decisions significantly affect liquid and overnight fund categories,” said a fund manager at a leading AMC.

Corporate and Money Market Funds Attract Inflows

Despite the headline outflows, some segments of the debt mutual fund space saw positive momentum in May:

• Corporate bond funds attracted ₹11,983 crore in net inflows, as investors looked for relatively stable returns and strong credit profiles.

• Money market funds, which invest in very short-term instruments, saw ₹11,223 crore in net inflows, benefitting from steady interest rates and low credit risk.

This reallocation indicates that investors are seeking a balance between safety and returns, particularly in short-duration, low-risk instruments.

Low Duration and Ultra Short Duration Funds Stay Resilient

Two other popular categories among conservative investors, low duration and ultra-short duration funds, continued their positive trajectory:

• Low duration funds saw inflows of ₹3,133 crore.

• Ultra short duration funds added ₹1,847 crore.

These strategies are particularly suitable in stable to mildly declining interest rate environments, where investors seek better returns than traditional bank deposits without locking in funds long-term.

Gilt Funds See Positive Flows for First Time in 2025

In a notable shift, gilt funds saw net inflows for the first time in 2025, especially in the regular gilt segment, which attracted ₹1,386 crore.

According to Nehal Meshram, Senior Analyst – Manager Research at Morningstar India, “The inflows into gilt and long-term debt funds reflect growing optimism about a prolonged rate cut cycle, which enhances the capital gain potential in long-duration bonds.”

When interest rates fall, long-duration government securities, such as those held by gilt funds, tend to deliver strong capital appreciation.

Medium and Long Duration Funds See Mild Interest

Driven by similar expectations, medium to long duration debt funds also witnessed modest inflows, though they remained small compared to short-duration funds.

The relatively cautious approach from investors here reflects a desire to wait for clearer signals from the Reserve Bank of India (RBI) regarding its monetary policy stance.

Redemptions Reflect Broader Portfolio Rebalancing

According to Vikas Gupta, CEO & Chief Investment Strategist, OmniScience Capital:

“The sharp outflows in debt funds reflect a shifting investor preference, with many moving capital into equities where they expect higher upside from potential rate cuts and economic growth.”

This trend underlines a broader rebalancing in portfolios, particularly among high-net-worth and institutional investors, who may be opting to increase equity exposure amid bullish market outlooks.

A Breakdown of Inflows and Outflows by Category in May 2025

The table clearly reflects that while overall debt inflows were negative, many interest-rate-sensitive and short-term instruments gained favour.

Outlook for Debt Mutual Funds

The outlook for debt mutual funds in the coming months hinges on multiple macroeconomic triggers:

• Expected interest rate cuts by the RBI, possibly in the second half of 2025.

• Monsoon and inflation trends, which could influence the central bank's decision-making.

• Global cues, especially from the US Federal Reserve and its stance on interest rates.

If interest rates decline, long-duration categories like gilt and dynamic bond funds may see renewed inflows. Meanwhile, short-duration funds are likely to maintain their appeal among conservative investors looking for better-than-bank returns with lower risk.

Key Takeaway for Investors

Investors need to align their debt fund choices with:

• Their investment horizon

• Risk appetite

• Expected interest rate movement

Short-duration funds offer a safer route for those with low to moderate risk tolerance, while long-duration funds, though volatile, offer the potential for higher gains in a falling interest rate environment.

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