BT Buzz: Gilt funds witness 237% higher inflows in April; should you invest?

BT Buzz: Gilt funds witness 237% higher inflows in April; should you invest?

If you are keen to invest in gilt funds, you must know while gilt funds do carry very little credit risk due to sovereign backing, they are prone to interest rate risks


  • Gilt funds received Rs 2,515.61 crore inflows in April compared to Rs 746.71 crore in March
  • All 29 gilt funds have returned in the range of 10-19 per cent
  • Gilt funds carry almost negligible credit risk and perform better during low interest rate regime
  • Experts say new investors are unlikely to fetch double digit returns of the past
  • Yields may still moderate further but economic uncertainties are abound to trigger volatility in gilt funds
  • Take into account YTM, modified duration, AMC charges and taxation before investing in a gilt fund
  • Debt funds with target maturity structures are a better choice over gilt funds

Debt mutual funds may have been in the news for all the wrong reasons over the last one and half years, there is one category that is sitting on high double-digit returns at a time when even equity returns are dismal. Gilt and Gilt with 10-year Constant Duration categories have returned 15 per cent and 17 per cent, respectively in last one year. Returns for three and five years horizon are also in the range of 8-10 per cent.

In fact, the gilt category received inflows of Rs 2,515.61 crore in April compared to just Rs 746.71 crore in March. Now this is where the trouble begins. After the closure of six debt fund schemes by Franklin Templeton, investors have virtually abandoned the credit risk category. It witnessed outflows of Rs 19,238.98 crore in April. On the other hand, inflows in gilt funds, that carry negligible credit risk, more than doubled in a month. If you are keen to invest in gilt funds, you must know while gilt funds do carry very little credit risk due to sovereign backing, they are prone to interest rate risks. Experts believe new investor are unlikely to fetch double digit returns as we are witnessing today. Let's understand gilt funds in detail:

What are gilt funds?

Gilt funds are medium to long duration funds, which invest in government securities maturing between 3 and 20 years. The gilts could be of central and state governments both. Since we don't expect governments to go broke, these are considered the safest form of debt fund investments with negligible credit risk. However, interest rate cycle has a major role to play in how a gilt fund performs. It is called a duration risk. The longer the maturity profiles of the instruments, the higher the duration risk. If interest rates increase, the prices of the underlying debt securities will fall to match the higher return. As a result, your gilt fund will show negative returns. And when you enter a low interest rate regime, the returns go higher - as has happened in the current scenario with the RBI decreasing the interest rates for over a year now. The repo rate currently stands at 4.4 per cent, the lowest ever.

"Gilt funds are different from other bond funds because they are not exposed to credit risk. However they are exposed to interest rate movements and as such, are advised only for those who are aware of these risks and are prepared to accept them. These risks shouldn't be taken lightly and retail investors would be well served to be cautious when investing in them," says debt market expert Rajiv Shastri.

Should you invest in gilts now?

The answer lies in capturing the future movement of interest rates. With the government having raised its gross market borrowing target for the current financial year to Rs 12 lakh crore from the budgeted Rs 7.8 lakh crore, yields on government securities are expected to come under pressure. However, marketmen believe there could be another round of at least 100 bps reduction in repo rate in FY21 as the economic growth will take a hit due to coronavirus lockdown.

"If the GDP falls, the RBI will have to cut rates to fund the growth. Keeping that in mind, gilt funds stand out among other debt investments if you have a six-nine months time horizon," says certified financial planner Pankaaj Maalde. However, he cautions that other factors such as currency movement, crude oil prices and interest rate in global economies also influence RBI's move on policy rates. "With uncertainties around how crude and currency will play out in the short-term, you need to be careful about investing in gilt funds."

That said, if you invest in gilt funds on expectations of receiving similar returns as today, you could be in for a disappointment. "While gilt funds have delivered good returns over the last year or so, this cannot be the only reason for either investing in, or remaining invested in them. And while it is expected that long-term yields will continue to moderate, one needs to bear in mind that there are considerable uncertainties associated with this view. In addition, gilt funds are quite volatile and this needs to be kept in mind when investing in them," says Shastri.

How to choose a gilt fund

There are 29 gilt funds in the market, as per Valueresearch data. All of them returned in the range of 10-19 per cent in last one year. Since all gilt funds invest in government securities, how to select in which fund to invest? Experts say take into account the maturity of papers a fund has invested in and the average yield on the same along with the cost structure, that is, AMC charges. "You need to check the yield-to-maturity, modified duration and expense ratio," suggests Maalde.

Factor in taxation as well. If you hold it for more than three years, at 20 per cent with indexation, the tax rate is still fine, but if you withdraw the amount within three years, you pay taxes as per your slab rate.

"Gilt funds are not a product to be held for more than three years only to save taxes if you have already fetched returns of a falling interest rate cycle. Once you achieve the target, you need to exit. If you are in 30 per cent tax slab and exit with 8 per cent yield, the net return that you will get will be around 5.5 per cent. So, keep that in mind," says Maalde.

Thus, if you are a new investor, invest in gilt funds with the outlook that your principal will stay protected and you will fetch average returns. Don't expect spectacular returns of the past. In fact, debt funds with target maturity structures could be a better choice over gilt funds. Such funds invest in longer maturity papers initially and switch to shorter maturity papers as the maturity period of the fund comes closer.

"Their duration starts at three, five, and 10, etc, and keeps falling over the life.  That way if you hold to maturity you don't have duration risk. These funds exist - and with high quality credit. Bharat Bond, some corporate bond funds, and some banking and PSU funds have target maturity structures. They are called roll-downs also. You can just check the duration of them and match it to your investment goal tenure," explains Radhika Gupta, CEO, Edelweiss Mutual Fund.

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