The Indian mutual fund landscape is witnessing a stark divergence in investor preference. While equity and hybrid funds continue to attract robust inflows, plain-vanilla debt mutual funds are struggling to keep pace, recording significant net outflows in 2025.
The total assets under management (AUM) for debt funds grew 1.3 times since November 2023, reaching ₹20 trillion by November 2025. In sharp contrast, hybrid and equity fund assets surged 1.8 times over the same period. Hybrid funds stood at ₹11.4 trillion and equity funds at a massive ₹35.4 trillion as of November, according to data from the Association of Mutual Funds in India (Amfi).
The Taxation Overhaul and Its Impact
The primary reason for this slowdown, experts point out, is the significant taxation change implemented on 1 April 2023. The government removed the indexation benefit for debt mutual funds. Previously, long-term capital gains from these funds were taxed at 20% with indexation, which adjusted the purchase price for inflation, lowering the tax liability.
Now, for debt funds investing less than 35% in equity and purchased on or after 1 April 2023, the entire gain is taxed at the investor's applicable income tax slab rate, regardless of the holding period. This has substantially reduced post-tax returns for many investors.
"Since debt mutual funds are taxed at the investor’s applicable marginal rate, post-tax returns have declined for most investors," explained Sirshendu Basu, Head of Product Management & Strategy at Bandhan AMC. He added that with AAA-rated debt funds offering around 6.75% pre-tax, investors are exploring hybrid categories for better post-tax outcomes, albeit with higher risk.
Awareness Gap and Retail Exodus
Compounding the tax issue is a persistent lack of retail awareness about the role of debt funds. Sneha Pandey, Fund Manager for Debt at Quantum Mutual Fund, noted that equity investing has been successfully marketed around wealth creation and SIPs, while debt is poorly understood for portfolio stability and income generation.
This knowledge gap has led investors to either chase growth through equity or seek safety in fixed deposits (FDs), leaving little room for debt mutual funds. The data reflects this trend: the share of retail and high-net-worth individuals (HNIs) in debt fund assets fell from 24% in September 2024 to 21% in September 2025.
Meanwhile, debt funds witnessed net outflows of ₹22,105 crore in 2025, a dramatic reversal from the inflows of ₹50,379 crore seen in the comparable period last year.
The Shift to Hybrid Alternatives
The taxation structure makes certain hybrid categories comparatively attractive. For hybrid funds with 35% to 65% equity exposure, gains realised after a holding period of 24 months are taxed at a flat rate of 12.5% (without indexation), which can be beneficial for investors in higher tax slabs.
This has fueled the migration towards hybrid schemes. Basant Bafna, Head of Fixed Income at Mirae Asset Investment Managers (India), stated that new money is now being allocated to debt funds purely based on category merits, as the grandfathering benefit protects only pre-April 2023 investments.
Looking ahead, the industry is pinning hopes on a potential policy reversal. Ahead of the Budget, Amfi has formally requested the government to restore the indexation benefit for debt mutual funds to create a level playing field.
Fund managers anticipate steady, but not spectacular, growth for debt funds. Killol Pandya, Head of Fixed Income at JM Financial AMC, believes they have a long way to go to reach the majority of small-ticket investors. However, Bafna points out that debt funds are becoming more attractive on a pre-tax basis, with low-duration funds offering yields 0.30-0.40% higher than one-year FDs, and short-duration funds offering 0.50-0.75% more.
