Mutual Funds Eye More Allocation in SDLs: Benefits, Risks & Returns Explained

The pressure from state bonds weighs on the market due to higher supply. SDLs are even traded at higher yields than 'AAA'-rated PSU corporate bonds for maturities of 10 years.

With states planning to raise funds to the tune of Rs 5 lakh crore in the fourth quarter, mutual fund houses are keenly looking forward to participating in them for higher yields. Market participants said that the spread between government and state bonds, which have already more than doubled to 85 basis points, are expected to widen further.

“We are planning to increase our allocation in SDL (State Development Loans), as spreads have reached near recent highs — driven purely by liquidity shortages and oversupply. said Abhishek Bisen, head of fixed income at Kotak Mutual Fund. He explained that given these attractive spreads, the 2030–2035 maturities offer far better risk-reward profiles. “We plan to scale up to 20–30% on SDLs,” he added.

What did Rajeev Radhakrishnan say?

Rajeev Radhakrishnan, head of fixed income at SBI Mutual Fund also believes that the substantial SDL supply pipeline will provide attractive entry opportunities. “The SDLs could present strong tactical plays amid potential volatility from elevated issuance,” he added. 

However, SBI Mutual Fund is not looking to extend duration via SDLs, and the focus will stay targeted around the 10-year tenor to balance yield pickup without meaningfully shifting the portfolio’s interest rate sensitivity. During the same period last year, states borrowed Rs 4.3 lakh crore. So far in the quarter, they have borrowed Rs 69,915 crore. 

In FY26, the Indian states are projected to record gross market borrowings at Rs 12.5 lakh crore on a gross basis, in line with central borrowings. In the next fiscal year, state borrowings are expected to be around 80% of the central government borrowing.  

What did Anurag Mittal say?

Agreed Anurag Mittal, head of fixed income at UTI Mutual Fund, “I believe this quarter will present compelling opportunities in SDLs. With elevated issuance in the final quarter, primary auctions often yield attractive picks in SDLs, which are relatively illiquid compared to G-Secs. These auctions are prime for portfolio construction.” 

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Mittal added that the fund house will actively participate to capture the ongoing spread widening between SDLs and G-Secs. Right now, the 10-year SDL yields around 7.5%, versus 6.68% for the 10-year G-Sec—a solid 82 bps spread. It could easily widen to around 95 bps.