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Investing in gilt funds may look attractive right now to many investors. The average returns of these funds are in double-digit in the past one year. Returns of dynamic gilt funds category are at 11%, and gilt funds with the 10-year constant duration are at 11.7%.

Besides double-digit returns, investors don’t need to worry about credit risk or the issuer defaulting on the repayment. They have a sovereign guarantee as the Central government issues these securities.

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But most analysts suggest that retail investors should stay away from these funds. “While there is no credit risk, these funds are sensitive to interest rate movement. They are volatile, and there can be periods of negative returns. If a retail investor doesn’t have guidance from an advisor, we usually suggest that these funds are best avoided," said Kaustubh Belapurkar, director, fund research, Morningstar India Advisor, a platform that offers mutual fund research and investment management services.

Most of their upside is already captured, according to analysts. They typically give double-digit returns when interest rates are falling. Bankers and debt mutual fund managers don’t see interest rates going below the current levels. Gilt funds may, therefore, not repeat the last calendar year’s performance in 2021.

“Right now, investors should be looking at shorter duration debt funds," said Belapurkar.

INVESTMENT STRATEGY

There are two ways investors can take advantage of the gilt fund. Gilt funds can be used for tactical exposure. It means investors get in when the interest rates are falling and redeem when they start rising.

“For retail investors, it’s not possible to take a call on interest rate movement. That’s why we suggest that they should stay away unless they have an advisor who can guide them on when to enter and exit," said Vidya Bala, co-founder, Prime Investor, a mutual fund research portal.

The other way to invest in a gilt fund is for the long haul. “Only if investors are willing to stay for over five years, they can make gilt funds as part of their portfolio. Over the long term, investors can ride the interest rate cycles," said Belapurkar.

If you plan to invest in gilt funds for the long term and can stay put through the volatility and periods of negative returns, schemes in gilt with the 10-year constant duration could be a better option.

“In the regular gilt funds, fund managers take a call on the interest rate movement. Accordingly, they manage the portfolio. Their calls can, however, go wrong sometimes. In the 10-year constant duration category, the fund manager can only include securities of the specified duration. There’s not much active management in it," said Bala.

To explain the difference between the two categories, Bala draws an analogy from equity funds. There are actively managed funds, and then there are exchange-traded funds (ETFs) that mimic a benchmark. Dynamic gilt funds are like actively managed equity funds, whereas 10-year constant duration gilt funds are like ETFs.

Unless you can stomach the volatility or have an advisor to guide you, it’s best to avoid gilt funds.

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