Gilt funds are a specific type of mutual funds that primarily invest in government securities, forming part of the broader category of debt funds. To grasp the concept of gilt funds, it is essential to have a clear understanding of government securities.
Government securities, also known as G-Secs, are debt instruments issued by the Central Government or State Governments to raise funds for public expenditure. These securities are issued through the country’s central bank, such as the Reserve Bank of India (RBI). The term “gilt” is used to describe these funds because they carry minimal default risk because of the sovereign guarantee and high credit rating associated with government-backed securities.
There are two main categories of government securities:
Short-term securities – such as treasury bills, have maturities lasting less than one year and are exclusively issued by the central government.
Long-term securities – represented by government bonds or dated securities, have maturities more than one year and are issued by both the central and state governments.
Risks Associated with Gilt Funds
Default Risk
Among the various risks associated with debt instruments, default risk holds paramount importance. It refers to the likelihood that the borrower might not fulfill timely and complete principal and interest payments. Gilt funds, however, are not susceptible to default risk because they are backed by the government, which carries a sovereign rating. This distinguishes them from corporate bonds, which typically entail default risk.
Duration Risk
Understanding the correlation between the prices of debt instruments and their yields is essential. Bond prices exhibit an inverse relationship with interest rate movements—when interest rates rise, bond prices fall, and vice versa. The sensitivity of debt instrument prices to changes in interest rates is termed duration risk.
This risk is particularly relevant to debt instruments with extended or higher maturities. Gilt funds, with maturities spanning from 90 days to over 30 years, are exposed to duration risk. Longer-duration gilt funds face higher duration risks. However, if the intention is to hold the bond until maturity, this risk is typically mitigated over time.
How do Gilt Mutual Funds work?
Gilt Mutual Funds offer a reliable investment opportunity for conservative investors who are looking for a balance of reasonable returns and low risk. The Reserve Bank of India (RBI) provides funds to the Government of India, and in return, the RBI issues government securities.
Gilt Funds invest in these securities, creating a mutually beneficial relationship where the government obtains the necessary funds and the Gilt Funds secure a stable investment avenue. These securities are referred to as “gilt” because they have a sovereign guarantee and rating, indicating a minimal risk of default. Market fluctuations influence gilt funds and perform best in a declining interest rate environment.
Advantages of Investing in Gilt Funds
Liquidity
Investing in G-secs through mutual funds, including gilt funds, offers the advantage of liquidity. Mutual funds provide a convenient exit option, eliminating concerns about the ease of liquidating investments. Furthermore, since gilt funds primarily consist of government securities with a sovereign rating, they boast the highest liquidity among all debt instruments.
Access to Government Securities
G-secs are typically dominated by large players like banks and financial institutions, engaging in market lot sizes ranging from Rs 20 crore to Rs 25 crore. Gilt mutual funds enable smaller investors to participate in government securities with significantly lower investment amounts. Additionally, for those seeking to diversify across multiple government securities with a modest investment, Gilt funds emerge as an optimal investment choice.
Returns
Gilt funds offer returns influenced by the Yield to Maturity (YTM). Prudent investment decisions consider the relationship between current returns and YTM. For instance, during periods when current returns are in the double digits but YTM hovers between 5% and 6%, investing might be less advisable, given the forward-looking earnings indicated by YTM are comparatively lower.
Security
Gilt funds provide access to the highest quality government papers, mitigating credit risk. As these funds predominantly invest in government securities, which carry a sovereign guarantee, the risk associated with credit defaults is minimal, ensuring a higher level of security for investors.
Who Should Consider Investing in Gilt Funds?
Gilt funds can be considered by investors who are interested in incorporating debt instruments into their investment portfolio. These funds are particularly suitable for individuals seeking secure investment options with a paramount focus on preserving the principal amount and minimal risk tolerance. Gilt funds are especially well-suited for investors who prefer to avoid any exposure to credit risk.
Types of Gilt Funds
Investors have three types of gilt funds to consider for their investment portfolio:
Gilt Fund
This category of gilt funds invests in government securities with varying maturities. According to SEBI’s categorization mandate, at least 80% of the portfolio of such funds must be allocated to government securities. The remaining 20% is typically invested in debt instruments like T-bills, cash and cash equivalent securities, certificate of deposit, commercial papers, among others.
Gilt Funds with a 10-Year Constant Maturity
In this type of gilt fund, the portfolio is structured to have exposure to government securities with a fixed 10-year duration. Similar to regular gilt funds, SEBI mandates that at least 80% of the portfolio should be allocated to government securities.
Target Maturity
Target maturity funds, a relatively recent addition to the market, focus solely on government securities, either from the central or state governments, with a specific maturity. Although SEBI does not mandate specific allocation percentages for this category, these funds usually have fixed maturities. They can be likened to open-ended fixed maturity plans (FMPs), aligning with the objectives outlined by the funds rather than strict regulatory categorization.
Taxation
Gains from Gilt Funds are taxed as per marginal tax rate of the investor. This means that gains are added to the investor’s taxable income and are taxed at the investor’s marginal tax rate. Please note that the gains are only applicable on redemption unlike Fixed Deposits where TDS is applicable every year.
FAQ’s
1. How long should I stay invested in Gilt Mutual Funds?
You should invest in Gilt Funds by matching your investment horizon with the maturity of the Gilt Mutual Fund. While these funds may experience volatility, particularly during significant economic events or changes in interest rates, having a long-term perspective and exercising patience is crucial for navigating through these fluctuations.
2. Can Gilt Funds Experience Volatility?
The gilt fund is sensitive to interest rates. Rise in interest rates reduce the gains and reduction in interest rates increase the gains in Gilt Funds.
3. Are Gilt Funds Suitable for Long-Term Investments?
You can consider investing in gilt funds for the long-term based on your investment horizon. They provide decent rates of returns and a course of risks.
4. Can I redeem Gilt Funds Anytime?
Gilt funds offer liquidity, which means you can invest at any time and withdraw at any time, depending on your needs.
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