What are gilt funds? They are a popular way of investing in the financial markets. They offer diversification, professional management, and convenience to investors. There are various types of mutual funds, such as equity, debt, hybrid, and thematic funds. In this article, we will focus on one type of debt mutual fund, namely gilt funds.
What are gilt funds?
Gilt funds are a type of debt mutual fund that invests mainly in government securities. Government securities are bonds or bills issued by the central or state governments to raise funds for various purposes. These securities have different maturities, ranging from a few days to 30 years or more.
Gilt funds have some distinctive features that make them different from other debt mutual funds. Some of these features are:
- Low credit risk: Gilt funds have minimal credit risk, as the government is unlikely to default on its obligations. Unlike corporate bonds, which may face the risk of downgrade or default, government securities are considered to be the safest in terms of repayment.
- High interest rate risk: Gilt funds are sensitive to interest rate fluctuations. When interest rates rise, the prices of government securities fall, and vice versa. This affects the net asset value (NAV) and returns of gilt funds. The longer the maturity of the securities, the higher the interest rate risk.
- Moderate returns: Gilt funds can offer moderate returns with low risk, depending on the interest rate scenario. They are suitable for investors with a long-term horizon who want to invest in safe instruments. However, they may not be able to beat inflation or generate high returns like equity funds.
Why invest in gilt funds?
Gilt funds have some benefits that make them attractive for certain investors. Some of these benefits include:
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- Safety of capital: Gilt funds are ideal for investors who want to preserve their capital and avoid any loss due to credit risk. They can also be used as a hedge against market volatility, as they tend to perform well when equity markets are bearish.
- Tax efficiency: Gilt funds are taxed as debt mutual funds. They are subject to short-term capital gains tax (STCG) if held for less than three years and long-term capital gains tax (LTCG) if held for more than three years. The STCG rate is as per the investor’s income tax slab, while the LTCG rate is 20% with indexation benefit. The indexation benefit allows the investor to adjust the cost of acquisition of the units with inflation, thereby reducing the taxable amount.
- Liquidity: Gilt funds are highly liquid, as they invest in government securities that are traded in the secondary market. The investor can redeem the units of gilt funds at any time, subject to the exit load, if any. The exit load is a fee charged by the fund house for early redemption of the units.
What are the risks of investing in gilt funds?
Gilt funds are not risk-free, as they are exposed to some factors that can affect their performance. Some of these factors are:
- Interest rate risk: As mentioned earlier, gilt funds are sensitive to interest rate movements. Interest rates are determined by various factors, such as inflation, economic growth, fiscal policy, monetary policy, and global events. A rise in interest rates can erode the value of gilt funds, while a fall in interest rates can boost their value. Therefore, the investor should have a view on the interest rate outlook before investing in gilt funds.
- Reinvestment risk: Gilt funds face the risk of reinvesting the coupon payments or the maturity proceeds of the securities at a lower rate than the original rate. This can reduce the returns of gilt funds over time. Reinvestment risk is higher when interest rates are falling.
- Opportunity cost: Gilt funds may have a lower return potential than other debt mutual funds or equity funds, especially in a low interest rate environment. The investor may miss out on higher returns from other investment options by investing in gilt funds.
What is the current scenario of gilt funds in India?
Gilt funds have been witnessing a challenging phase in India in the recent past. The COVID-19 pandemic has led to a sharp decline in economic activity, resulting in lower tax revenues and a higher fiscal deficit for the government. To support the economy, the government has announced various stimulus measures, which have increased its borrowing requirement. The Reserve Bank of India (RBI) has also reduced policy rates and injected liquidity into the system to ease financial stress.
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These factors have created a situation of excess supply and low demand for government securities, putting pressure on their prices and yields. The 10-year government bond yield, which is a benchmark for gilt funds, has risen from 5.9% in April 2020 to 6.2% in February 2021. This has adversely affected the performance of gilt funds, as their NAVs have declined. According to the data from Value Research, the average return of gilt funds in the last year (as of February 12, 2021) is -3.4%, while the average return of debt mutual funds is 9.4%.
However, some experts believe that gilt funds may see a recovery in the near future, as the RBI may intervene to support the bond market and keep the yields under control. The RBI has announced various measures, such as open market operations (OMO), operation twist, and special OMO, to buy and sell government securities and manage the liquidity and yield curve. The RBI has also assured that it will maintain an accommodative stance and ensure ample liquidity in the system.
How Do You Compare Gilt Funds with Other Debt Mutual Funds?
Gilt funds are one of the many types of debt mutual funds available in the market. Each type of debt mutual fund has its own features, benefits, and risks and caters to different investor profiles and goals. Therefore, the investor should compare gilt funds with other debt mutual funds before making an investment decision. Some of the other types of debt mutual funds are:
- Corporate bond funds: These funds invest in corporate bonds, which are debt instruments issued by private or public sector companies. Corporate bond funds have higher credit risk than gilt funds, as the issuers may default on or delay the payment of interest or principal. However, they also have a higher return potential than gilt funds, as they offer higher interest rates than government securities. Corporate bond funds are suitable for investors who have a moderate risk appetite and a medium- to long-term horizon.
- Banking and PSU funds typically channel their investments into debt instruments issued by both banks and public sector undertakings (PSUs).Banking and PSU funds have lower credit risk than corporate bond funds, as the issuers are backed by the government or have a strong financial position. They also have lower interest rate risk than gilt funds, as they invest in shorter-duration securities. Banking and PSU funds are suitable for investors who have a low to moderate risk appetite and a short- to medium-term horizon.
- Dynamic bond funds: These funds have the flexibility to change the duration and composition of their portfolio according to the interest rate scenario. Dynamic bond funds can invest in various types of debt instruments, such as government securities, corporate bonds, money market instruments, etc. Dynamic bond funds have moderate credit risk and interest rate risk, depending on the fund manager’s strategy and outlook. They are suitable for investors who have a moderate risk appetite and a medium- to long-term horizon and who want to benefit from the changing interest rate environment.
- Liquid funds: These funds invest in money market instruments, such as treasury bills, commercial papers, certificates of deposit, etc. These instruments have very short maturities, ranging from one day to 91 days. Liquid funds have very low credit risk and interest rate risk as they invest in high-quality and short-term securities. They also have very high liquidity, as they can be redeemed within one working day. Liquid funds are suitable for investors who have a very low risk appetite and a very short-term horizon and who want to park their surplus funds for a short period of time.
How Do You Choose the Best Gilt Fund?
Choosing the best gilt fund depends on your financial goals, risk tolerance, and investment horizon. Gilt funds are debt mutual funds that invest mainly in government securities, which have low credit risk but high interest rate risk. Here are some factors that you should consider before investing in gilt funds:
- Fund performance: You should compare the past performance and risk-adjusted returns of different gilt funds over various time periods, such as 1 year, 3 years, 5 years, etc. You can also look at the benchmark and category average returns to evaluate how well the fund has performed relative to its peers and the market. However, you should remember that past performance is not a guarantee of future results, and gilt funds may be volatile in the short term due to interest rate movements.
- Fund expenses: You should check the expense ratio and exit load of the gilt fund before investing. The expense ratio is the annual fee charged by the fund house for managing the fund, and it reduces the net returns of the fund. The exit load is the fee charged by the fund house for redeeming the units of the fund before a specified period, usually one year. You should look for gilt funds that have a low expense ratio and exit load, as they can increase your returns in the long run.
- Fund manager’s track record: You should also review the fund manager’s experience and track record in managing gilt funds. You can check the fund manager’s profile, qualifications, tenure, and performance of other funds managed by him or her. You should look for fund managers who have a consistent and long-term track record of delivering superior returns with low risk.
- Credit quality: You should also look at the credit quality of the securities held by the gilt fund. Gilt funds invest mainly in government securities, which are considered to be the safest in terms of repayment. However, some gilt funds may also invest in state development loans (SDLs), which are issued by state governments and have a slightly higher credit risk than central government securities. You should look for gilt funds that have a high proportion of central government securities and a low proportion of SDLs, as they have lower credit risk and higher liquidity.
- Fund duration: You should also look at the fund duration, which is a measure of the sensitivity of the fund to interest rate changes.As the duration of the fund extends, the associated interest rate risk increases. Gilt funds can have different durations, such as short-term, medium-term, or long-term, depending on the maturity of the securities they hold. You should choose the fund duration that matches your investment horizon and interest rate outlook. For example, if you have a long-term horizon and expect interest rates to fall, you can choose a long-term gilt fund, as it can benefit from the price appreciation of the securities.
However, if you have a short-term horizon and expect interest rates to rise, you can choose a short-term gilt fund, as it can reduce the price depreciation of the securities.These are some of the factors that can help you choose the best gilt fund for your portfolio. You can also use online platforms, such as ET Money, Groww, or Alice Blue, to compare and invest in gilt funds. However, you should also do your own research and analysis before investing and consult a financial advisor if needed. Gilt funds are not risk-free, and they may not be suitable for everyone. You should invest in gilt funds only if you understand the risks and rewards involved, have a long-term horizon, and have a low to moderate risk appetite.
Conclusion
Gilt funds are a type of debt mutual fund that invests mainly in government securities. They offer investors safety of capital, tax efficiency, and liquidity. However, they also have interest rate risk, reinvestment risk, and opportunity costs. Gilt funds are suitable for investors who have a long-term horizon and a low to moderate risk appetite.
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The performance of gilt funds depends on various factors, such as inflation, economic growth, fiscal policy, monetary policy, and global events. Gilt funds have been facing a challenging phase in India due to the COVID-19 pandemic, which has increased the government’s borrowing requirement and put pressure on bond yields. However, the RBI has been taking measures to support the bond market and keep yields under control.
Gilt funds are not homogeneous, as they may differ in their objectives, strategy, portfolio, performance, and risk. Therefore, the investor should compare gilt funds with other debt mutual funds, such as corporate bond funds, banking and PSU funds, dynamic bond funds, and liquid funds, before making an investment decision. The investor should also consider some factors, such as fund performance, fund expenses, the fund manager’s track record, credit quality, and fund duration, before choosing the best gilt fund for their portfolio.
Gilt funds are not risk-free, and they may not be suitable for everyone. You should invest in gilt funds only if you understand the risks and rewards involved, have a long-term horizon, and have a low to moderate risk appetite. You should also do your own research and analysis before investing and consult a financial advisor if needed.
FAQs
Q. What are gilt funds?
Ans. Gilt funds are a type of debt mutual fund that invests mainly in government securities. Government securities are bonds or bills issued by the central or state governments to raise funds for various purposes. These securities have different maturities, ranging from a few days to 30 years or more.
Q. Why invest in gilt funds?
Ans. Gilt funds have some benefits that make them attractive for certain investors. Some of these benefits include:
Safety of capital: Gilt funds are ideal for investors who want to preserve their capital and avoid any loss due to credit risk. They can also be used as a hedge against market volatility, as they tend to perform well when equity markets are bearish.
Tax efficiency: Gilt funds are taxed as debt mutual funds. They are subject to short-term capital gains tax (STCG) if held for less than three years and long-term capital gains tax (LTCG) if held for more than three years. The STCG rate is as per the investor’s income tax slab, while the LTCG rate is 20% with indexation benefit. The indexation benefit allows the investor to adjust the cost of acquisition of the units with inflation, thereby reducing the taxable amount.
Liquidity: Gilt funds are highly liquid, as they invest in government securities that are traded in the secondary market. The investor can redeem the units of gilt funds at any time, subject to the exit load, if any. The exit load is a fee charged by the fund house for early redemption of the units.
Q. What are the risks of investing in gilt funds?
Ans. Gilt funds are not risk-free, as they are exposed to some factors that can affect their performance. Some of these factors are:
Interest rate risk: As mentioned earlier, gilt funds are sensitive to interest rate movements. Interest rates are determined by various factors, such as inflation, economic growth, fiscal policy, monetary policy, and global events. A rise in interest rates can erode the value of gilt funds, while a fall in interest rates can boost their value. Therefore, the investor should have a view on the interest rate outlook before investing in gilt funds.
Reinvestment risk: Gilt funds face the risk of reinvesting the coupon payments or the maturity proceeds of the securities at a lower rate than the original rate. This can reduce the returns of gilt funds over time. Reinvestment risk is higher when interest rates are falling.
Opportunity cost: Gilt funds may have a lower return potential than other debt mutual funds or equity funds, especially in a low interest rate environment. The investor may miss out on higher returns from other investment options by investing in gilt funds.
Q. How do you compare gilt funds with other debt mutual funds?
Ans. Gilt funds are one of the many types of debt mutual funds available in the market. Each type of debt mutual fund has its own features, benefits, and risks and caters to different investor profiles and goals. Therefore, the investor should compare gilt funds with other debt mutual funds before making an investment decision. Some of the other types of debt mutual funds are:
Corporate bond funds: These funds invest in corporate bonds, which are debt instruments issued by private or public sector companies. Corporate bond funds have higher credit risk than gilt funds, as the issuers may default on or delay the payment of interest or principal. However, they also have a higher return potential than gilt funds, as they offer higher interest rates than government securities. Corporate bond funds are suitable for investors who have a moderate risk appetite and a medium- to long-term horizon.
Banking and PSU funds typically channel their investments into debt instruments issued by both banks and public sector undertakings (PSUs). Banking and PSU funds have lower credit risk than corporate bond funds, as the issuers are backed by the government or have a strong financial position. They also have lower interest rate risk than gilt funds, as they invest in shorter-duration securities. Banking and PSU funds are suitable for investors who have a low to moderate risk appetite and a short- to medium-term horizon.
Dynamic bond funds: These funds have the flexibility to change the duration and composition of their portfolio according to the interest rate scenario. Dynamic bond funds can invest in various types of debt instruments, such as government securities, corporate bonds, money market instruments, etc. Dynamic bond funds have moderate credit risk and interest rate risk, depending on the fund manager’s strategy and outlook. They are suitable for investors who have a moderate risk appetite and a medium- to long-term horizon and who want to benefit from the changing interest rate environment.
Liquid funds: These funds invest in money market instruments, such as treasury bills, commercial papers, certificates of deposit, etc. These instruments have very short maturities, ranging from one day to 91 days. Liquid funds have very low credit risk and interest rate risk as they invest in high-quality and short-term securities. They also have very high liquidity, as they can be redeemed within one working day. Liquid funds are suitable for investors who have a very low risk appetite and a very short-term horizon and who want to park their surplus funds for a short period of time.
