POST demonetisation of high value currency notes, retail investors can look at gilt funds for higher returns. The government’s drive has given a big boost to liquidity in banks and interest rates are likely to come down as retail inflation, too, has dipped to a 24-month low of 3.6% in November 2016.
Long-term debt schemes like gilt funds benefit most in a falling interest rate regime as bond prices are inversely proportional to the interest rates. So, whenever yields fall, bond price rises and the rise in bond prices move up the net asset value (NAV) of debt funds. Any drop in yield will result in capital gains for investors. In fact, data from Association of Mutual Funds in India show net monthly inflows in gilt funds have been rising for the past few months as interest rates have started softening.
Mutual fund route.
Gilt funds of mutual funds invest in 10-year benchmark government bonds and 91-day and 180-day treasury bills. While debt funds invest in corporate and government debt paper, gilt funds invest in government securities. The maturities of G-secs vary as the government issues paper of various tenure and can be short-, medium- or long-term.
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The sovereign risk is next to nil as the government has almost-zero risk of defaulting. However, the interest rate risk rises as the market price of debt securities varies with fluctuating interest rates. In fact, gilt funds have given negative returns in years when interest rates rose sharply. Analysts say timing is very important while investing in gilt funds—invest when the rates are falling and redeem before interest rates start moving up.
Returns-wise, medium and long-term gilt funds soared over 16% in the last one year, the best performance among widely traded asset classes. Even short-term gilt funds have gained over 3% in the last three months and are up 12% in the last one year.
Invest directly in G-secs
Retail investors with a demat account can even invest directly in government securities. In August, RBI issued guidelines allowing retail investors access to NDS-OM (Negotiated Dealing System-Order Matching) platform to buy government securities. A retail investor can give instructions to his Depository Participants (DP) bank to buy/sell government securities at the prevailing market prices on NDS OM. The DP bank would execute the trade and transfer securities seamlessly from the bank’s SGL account to the investor’s retail account.
Direct access to government securities gives retail investors access to fair market prices and there is seamless transfer from the DP bank’s SGL account to the investor’s demat account. However, the investor must have the expertise to understand the complex nature of fixed income securities.
Brijesh Damodaran, founder and managing partner of BellWether Advisors LLP, says investment in gilt funds is only for the informed investor, who can understand the movement in bond prices and can withstand the volatility, if any sudden change in direction of rates happens as seen in 2013.
Coming to tax treatment, G-Sec attracts tax on both the interest income and capital gains if traded before maturity. The interest income attracts tax at the marginal tax rate and capital gains is taxed at 10%. However, there is no capital gains tax if held till maturity.