For the first time since March 2023, the rolling yearly returns on debt funds were better than the returns on diversified equity funds. But that is not all. Even on a full year basis, FY2025 may be the first year since FY2011, when the debt funds have given higher returns compared to the equity funds. In the last few years, it was all about equity funds; and that is evident in the way equity fund SIPs have proliferated in India. Equity funds have literally become a retail obsession, and that growth had come at the cost of debt funds. That seems to be changing now! 

One of the subtle shifts that happened in the last 6 months is the change in the share of debt funds in overall AUM. For example, between September 2024 and February 2025; the share of debt funds in the overall mutual fund AUM in India has grown from 22.32% to 26.47%. In the same period, share of equity funds in the overall mutual funds AUM has fallen from 46.36% to 42.45%. In absolute terms, the equity funds still dominate, but the shift back to debt funds seems to be happening. In fact, the equity sell-off also impacted hybrid and passive funds. 

Taxation is still the issue. For instance, equity funds are taxed at a lower rate in terms of short-term capital gains and in terms of long-term capital gains. Also, in the case of pure debt funds (having over 65% in debt), there is no concept of LTCG and STCG. Gains are taxed under other income, irrespective of the holding period. These changes had impacted debt funds to some extent. However, the latest budget in July saw that gap cut. For instance, equity funds now attract STCG at 20% and LTCG at 12.5%. Also, now debt funds have to be held for just 2 years to classify as long term. These factors have combined to improve the flows into debt funds, as is evident in the AUM share of debt funds. The falling interest rates and tight liquidity are making debt relatively more attractive. 

But the real good news in this shift is that asset allocation considerations are back. Debt has merits, even beyond taxation. It is safe, returns are assured, it is more predictable and cash flows can feed the needs of people. That is not something you can count on equities for, although they are long term wealth compounders. These changed dynamics are forcing the investors to look at debt funds more proactively as part of asset allocation. In the final analysis, debt is not just about liquidity, safety, returns or tax. It is all about balance in asset allocation!