Gilt funds, which primarily invest in government securities (G-secs) and securities issued by state governments, have given double-digit returns over the past one year. Returns from gilt funds have risen as the Reserve Bank of India (RBI) has been cutting policy rates, leading to reduction in yields on G-secs. As G-sec yields fall, their prices go up. In its monetary policy last week, the central bank once again cut repo and reverse repo rates by 40 basis points (bps) each, which would impact gilt fund positively.
Not surprisingly, investors’ interest in gilt funds is also on the rise. There was a sudden jump in the net inflows of gilt funds in April. These funds saw net inflows of ₹2,516 crore in April, the highest in the past six months, according to data from the Association of Mutual Funds in India (Amfi). Since gilt funds invest in G-secs, which have a sovereign guarantee, they carry low credit risk.
As on 22 May, the returns from the gilt funds category with 10-year constant duration are 5.56% and 17.55% for the three-month and one-year periods, respectively, according to data from Value Research. The other gilt fund category, where funds can keep G-secs of different durations, has given 4.95% and 15.24% over the same time periods, respectively. Both categories invest almost their entire portfolios in G-secs.
With gilt funds giving far better returns than other debt fund categories recently, should you invest in them? “There is a lot of money flowing into these funds, but they are not a great product for retail investors. Many retail investors don’t realize that gilt funds have duration risk—change in interest rate can deeply impact returns. A rise of 1% in interest rate can lead to up to 8% decline in returns," said Radhika Gupta, CEO, Edelweiss Asset Management Ltd.
Gilts can be highly volatile as they are sensitive to the interest rate movement. For example, SBI Magnum Gilt Fund has the highest assets under management (AUM) of ₹2,433 crore among all gilt funds as on 30 April. In the past, the fund has given returns of 6.24% in a week (19-26 August 2013), but it has also seen a fall of 9.6% in a week (2-9 January 2009). Similar data is available for other gilt funds as well. It is difficult for retail investors to stomach such volatility.
The returns on gilt funds rise when interest rates are falling and vice-versa. These funds are also actively managed. Fund managers buy and sell securities depending on their view on interest rate movement. They can increase the average portfolio maturity when rates are falling and decrease it when rates rise as bond yields and prices are inversely proportional.
The only way investors can manage volatility in a gilt fund is by staying with it for a long duration, which allows them to benefit from a cycle of rising and falling interest rates. The five-year average returns, as on 22 May, for the gilt category is 8.92% and 10-year returns are 8.69%. For gilt funds with 10-year constant duration, the five-year returns are 10.55% and 10-year returns are 9.75%.
If you are prepared for high volatility, one way is to take help. Financial advisers can invest a portion of your debt fund portfolio in gilt funds and guide you about when to enter and exit. “In gilt funds, the entry and exit need to be tactical. But for retail investors, timing the entry and exit is not possible on their own," said Malhar Majumder, a Kolkata-based financial planner and partner, Positive Vibes Consulting and Advisory.
Some financial planners do invest in them as they have negligible credit risk, and not due to the returns. But, typically, even they keep a minimum investment horizon of four-five years due to the volatility. “If an investor wants a low-risk portfolio, we do look at gilts, but with a longer investment horizon. We also use other options to diversify the portfolio," said Suresh Sadagopan, founder of Ladder7 Financial Advisories.
If you are investing on your own, you can look at other debt fund options that have low credit risk. One option is banking and PSU debt funds. These schemes invest in papers of private and public sector banks, non-banking financial companies, and other government entities. These funds are also well-diversified with the average number of securities at 69. Before you invest in these funds, ensure that the scheme has at least 85% of the investment in AAA-rated papers. Moreover, these funds, typically, have shorter durations, so they won’t be highly sensitive to interest rate risk.
Another option is Bharat Bond ETF that give some predictability of returns due to the roll-down strategy they follow, provided investors hold the units to maturity. Prices on these funds are also sensitive to interest rate movement, but not to the extent of gilt funds. You can also diversify in traditional instruments such as RBI (taxable) bonds and post office savings schemes.
When investing, don’t get swayed by returns alone, understand the risk associated with the instrument and assess if it suits your investment horizon. While no one can predict where interest rates move from here, experts said there is little scope for rates to fall much lower than the current levels. If interest rates start to rise, you could end up in losses.