- As interest rates have come down, shall you look to invest in gilt funds?
- Read this post to know whether it is the right time to do so or not?
Gilt Funds or government securities funds are those funds that invest in bonds issued by the government of India. The government is the largest borrower in the Indian debt markets, it borrows money by issuing securities of various periods. This is done to fund government’s expenditure on various things such as infrastructure, social spending, health, defence, education, etc. Government securities are the highest-rated bonds in the country since the government is the guarantor in this case. In the last one-year, gilt funds have been the best performing category of debt funds and most of these have delivered a double-digit return. In fact, these funds have also beaten all equity funds when it comes to returns.
So, Does it Make Gilt Funds a Good investment option?
Before making that decision, let us fully understand how gilt funds operate and are there any risks associated with these funds. Basically, debt funds have two kinds of risk, these are:
CREDIT RISK – This is the risk of a credit default by a company whose bonds the debt fund is holding. In the recent past, we have seen some companies defaulting on their debt obligations, leading to negative returns from some debt funds. Gilt funds do not carry any credit risk theoretically since the government of India is the borrower and they will not default. Albeit there have been certain cases in the past like Argentina, Venezuela and Zimbabwe where governments have defaulted but these have been exceptions.
DURATION RISK – This is the risk of movement in bond prices due to interest rates in the economy. Interest rates and bond prices are inversely related, so when interest rates go up, bond prices go down and vice versa. So, if interest rates go down, gilt funds will give positive returns which have been the case in the last couple of years. However, when interest rates were going up between 2009-2013, gilt funds delivered negative to low single-digit returns. Another thing to watch out for is the duration of the fund. Simply put, the duration is the period till which bonds held in a debt portfolio will mature. Gilt funds have long durations of around 10 years and hence carry significant duration risk in the short term. However, if one intends to hold the fund till the duration, say 10 years then there is no duration risk.
To make the kind of returns in gilt funds like the last 2 years requires a timely entry and exit before the interest rate cycle changes. Currently, we are in an economic environment where interest rates have been coming down, but this could reverse based on the movement in inflation, currency, and fiscal deficit. Returns in the last year have been between 10-15% for various gilt funds but if an investor were to enter today expecting similar returns in the next two years then he might be in for some disappointment.
Also, if you have funds that you want to park for a short period of less than 3 years, it’s better to stick to liquid, overnight, ultra-short or arbitrage funds which are safer for this time horizon. Most of the investors jump into funds looking at the recent performance but that might not be sustained. One would make money basis the future performance only which needs to be deeply understood.