As Gilt funds and underlying securities are traded in secondary markets, the prices vary if new papers are issued at a different rate.
Gilt funds are debt mutual funds that invest in government bonds and securities of various tenures. As the bonds and securities issued by the government bear sovereign guarantee, such securities are completely safe and have no credit risk. But such funds do carry interest rate risks.
As Gilt funds and underlying securities are traded in secondary markets, the prices vary if new papers are issued at a different rate. In case new government bonds and securities are issued at a higher rate, price of old papers with lower interest rate are traded at a lower price, bringing down the NAV of the existing gilt funds.
On the other hand, if a rate cut is there and new government securities are issued a lower rate, demand for old papers with higher interest rate go up and they are traded at a higher price, which resulted into higher NAV of the existing gilt funds.
Higher the duration of the government securities more will be swing in the prices in the secondary market and higher will be the fluctuation in NAV of the gilt funds. So, a low-duration Gilt fund is bear lesser risk than a medium-duration Gilt fund, while a long-duration Gilt fund would carry highest interest rate risk.
At the current scenario, with GDP growth plunged to 4.5 per cent, the Reserve Bank of India (RBI), in its monetary policy meeting on December 5, may cut the policy rates to give a boost to the economic activities despite a spike in food inflation.
“The RBI’s FY20 GDP estimate for FY20 will be revised downwards as we observe some economists on the street have lowered their GDP estimates to sub 5 per cent for FY20. The recent data on imports and exports also demonstrates slowdown in the domestic and global economy. Since January of 2019, the Reserve Bank of India has cut repo rates by 135 bps to account for easing inflation in the early part to growth concerns in the second half,”said Sudhakar Shanbhag, Chief Investment Officer, Kotak Mahindra Life Insurance Company Limited.
“If the MPC members believe that the recent increase in food inflation is transient and assign higher weightage to the moderating core inflation, they may continue to focus on reviving growth and look through the recent and upcoming inflation readings. They may then go ahead with the rate cuts believing that maintaining accommodative financial conditions in this subdued environment is essential. MPC members’ perception about ‘flexible inflation targets’ will be tested in the December policy. While there is room for monetary easing amid weakening growth, higher inflation trajectory poses risks to the pace and quantum of rate cuts,” Shanbhag added.
Rachit Chawla, Founder & CEO, Finway, also thinks that the RBI would give economic slowdown a priority over food inflation and said, “The root causes of the slowdown are lack of domestic demand and financial liquidity. In fact, market demand also depends on liquidity. Besides, the rate will not trigger food inflation as we had a decent monsoon in most parts of the country, and our supplier side is strong.”
So, it may be a high time to invest in Gilt funds as the imminent rate cut would provide a boost to funds having papers with higher interest rates. “Yes, it is a good time to invest in bond funds, but for short-term bonds of duration 1 to 3 years, because they will enjoy double benefit – lowering of interest rates and the comfort of liquidity,” said Chawla.