If your investment goal is to accumulate stable returns with no credit risk, gilt funds are the best. In a volatile market scenario, they are the safest and right choice to earn good returns.
Of late, many investors are confused. Market indices between January and July of 2020 came down drastically and then moved up significantly. Many investors are worried of the lost opportunities and waiting for prices to correct so that they can enter the market again. But, if you have an investment horizon which is short, then this is not the market to be in equity. Rather investors can look at gilt funds for the time being. Let us discuss in detail what are gilt funds and their nuances.
Understanding gilt funds
Whenever a state or central government requires funds, it approaches the Reserve Bank of India. The central bank then accumulates funds from insurance companies / banks and lends the money to the respective government. In exchange, RBI issues government securities for a fixed tenure. Gilt funds subscribe to these securities. These securities have varying periods of maturities ranging from medium to long term. Since gilt mutual funds’ investments are made to the government, they are quite safe.
Duration of gilt funds
Basically long term and short term gilt funds are available in the market. Long term gilt funds are those that have a long duration fund or bonds. The maturity period is higher than five years and can go even up to 30 years. Long-term gilt funds are riskier and volatile, as they are more sensitive to interest changes. Short term gilt funds, as the name goes, are short duration funds. These funds invest in short-term government bonds and long-term bonds with short-term residual maturities.
Advantages and associated risks
As gilt funds invest only in government securities that are of high credit quality, default risk is almost zero. These funds provide a moderate risk-free return in medium to long term. At the same time, gilt funds have their own set of risks as well. Under an increasing interest rate regime, the returns from gilt funds fall. The inverse relationship between bond prices and interest rates affects the returns of gilt funds. Though government securities are safe investment options, sometimes they are not as liquid as the other securities in the market.
Expenses and tax treatment
Gilt funds also charge a managing fee, namely, expense ratio. The expense ratio for all debt funds is capped at 2.25% on NAV by SEBI. The fund manager cannot charge more than this from investors. Investors should take care to note the expense ratio while choosing funds. Like other mutual funds, its taxation depends on the holding period of the investment. Accordingly, investors will be getting indexation and other allied benefits.
Gilt funds differ from other debt mutual funds as they invest only in government securities with varying periods of maturity. Generally, volatility of gilt mutual funds could be higher than liquid and short duration debt funds.
To conclude, if your investment objective is to accumulate stable returns with no credit risk, gilt funds are the best available schemes. In a volatile market scenario, they are the safest and right choice to earn good short-term returns.
The writer is a professor of finance & accounting, IIM Tiruchirappalli