What are Gilt Funds ?

Gilt Funds are type of debt funds that invest in Government Debt Securities. According to SEBI rules, at least 80% of funds should be invested in Government Securities( G-Secs). Government securities are a way RBI collects money from investors and gives to Central Government and State Government of India. These G-Secs have maturity ranging from 91 days to 40 years. The securities having maturity less than 1 year is called as Treasury Bills and more than 1 year are called bonds. These securities are traded in markets i.e say if you buy a 10 year G-sec bond with 7.5% returns today, then you can sell them in the market after 1 year as well. If you have a trading account with online broker like Zerodha, then you can buy/sell government securities on your own. Then the question arises why invest in Gilt Funds?

To invest directly in G-Secs, you can only do in multiples of Rs 10,000. Also, you have to choose a G-Sec maturity (1yr - 40yr). The higher the maturity more is the interest risk (explained below). Hence, less liquidity will be there for 40yr maturity, if you want to sell early. Also, you have to bid in auction for G-Secs whenever government will need funds. If you want to avoid these hassle, you can simply stick to Gilt Funds and buy/sell like other mutual funds on open market days. Retail Investors are finding these Gilt Funds very attractive during this Covid pandemic in 2020 as they are showing returns of 12-15%.(Gilt Funds returns). Can debt fund give such high returns? Let's understand.

Inverse relation between Interest rate and Gilt fund returns

Let's say In 2018, you bought a government securities worth Rs. 10k with 10 year maturity at 6% rate of return. Now in 2020, the interest rates have fallen to 4%, so government securities of worth Rs.10k with 10 year maturity are made available with 4% returns. Definitely in these times the demand for 6% return G-Sec rises (higher returns available) , therefore it trades at premium value 12k (assumption). Now, G-secs bought in 2018 have made gains of 2k (12k-10k) over 10k of investment i.e 20% returns. Hence, the return value is high and gilt funds are showing such high returns. Conversely, if you see the situation from 2010 to 2013, the interest rates rose to ~8% from ~5% and hence demand for G-Secs with 5% returns bought in 2010 are traded at discount and returns are negative. Due to changes in interest rate, there is a huge volatility in the returns, this is called interest risk and gilt funds are prone to such risks. Such fluctuations in interest rates makes it difficult to predict the actual returns for gilt funds over a period of time. On the other hand, the advantage of investing in Gilt Funds is the protection from credit risk i.e lending to government is a safe bet as government always (India) pays its debt i.e government is Lannister.(ref: Game of thrones). Moral is that, if you buy Gilt funds in 2020 and suppose the interest rates rises to 6% by 2022 then it is definite that you will suffer a loss, if you want to sell by 2022. Therefore, buy Gilt Funds only if you are expecting interest rates to fall more in near future.

Taxation : As they are debt funds, they will be taxed according to the tax rules for debt funds. For withdrawing gains before 3 years (Short Term Capital Gains), taxes will be as per income tax bracket. For withdrawing gains after 3 years (Long Term Capital Gains), taxes will be 20% after indexation (considering inflation).

Important Factors for choosing Gilt Funds : As every Gilt fund is investing into government securities, there is not much difference between the funds. Important factors to look into Gilt Funds are expense ratio and last 5-10 years returns. Lesser the expense ratio, better is the fund managed.

Thank You.

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