Government Securities vs Gilt Funds: Taxation, risk, return, liquidity compared

The safest mode of investment is investing in Government Securities (G-Secs) as the instruments are backed by the government and hence there are no credit risks. The Central Government issues both treasury bills and bonds or dated securities while the State Governments issue only bonds or dated securities, which are called the State Development Loans (SDLs).

Gilt Funds are part of the Debt Mutual Fund (MF) category that invest in various government securities of different duration and hence have similar risk and return profile.

Risk

G-Secs carry practically no risk of default, and hence, are also called risk-free gilt-edged instruments.

With G-Secs in their portfolios, the Gilt Funds also have no credit risks, but such funds do have duration risks.

When a G-Sec is issued at a higher interest rate than the G-Secs in the investment portfolio of a Gilt Fund, the market value of the G-Secs with lower interest rate falls, dragging the Net Asset Value (NAV) of the Gilt Fund down. Similarly, Gilt Funds gain, if subsequent G-Secs are issued at lower interest. This risk increases with the duration of G-Secs.

Return

In the absence of risk, the return on such securities are lower than the instruments having risk factors associated with them.

As Gilt Funds invest in G-Secs, they also produce similar returns as that of G-Secs, but the overall return may vary depending on the duration risks the funds face.

Liquidity

G-Secs are issued with a specific maturity period, but may be traded in the secondary market within the maturity period, but with market risks.

Open ended Gilt Funds don’t have any specific maturity period and may be redeemed with the Asset Management Company (AMC) that issued the fund, or may be traded in the secondary market as well any time, and hence, have better liquidity.

Taxation

Almost all the G-Secs are taxable securities and hence the interest received on such investments are taxable.

On the other hand, despite having G-Secs in their portfolios, investments in Gilt Funds are treated as capital investments and capital gain tax is applicable on the gains on such funds. While short-term capital gains (STCG) are clubbed to the total income of an investor and taxed according to his/her income tax slab, indexation benefits are available on long-term capital gain (LTCG) and 20 per cent tax rate is applicable on gains after indexation.

So, investments in Gilt Funds have better tax advantage over direct investments in G-Secs.