Why You Should Stay Away from Gilt Funds?

For an investor, the safety of capital is the top priority along with good returns. And, GILT Funds offers the both. In the past one-year period, returns from GILT Funds have risen significantly due to multiple interest rate cuts by RBI and are giving double-digit returns.

According to Valueresearchonline.com, the 6 months and 1-year returns from the GILT funds’ category are 5.41% and 10.57% respectively. However, despite its strong performances, GILT Funds are not recommended for retail investors. 

Let’s check out the reasons why it is not recommended and the alternatives to GILT Fund.

Why You Should Avoid GILT Funds?

GILT Fund primarily invests in government bonds known as G-Secs, which provides safety of capital and promises to pay a certain sum of fixed interest rate over the period.

In GILT Fund, the returns are highly influenced by the change in interest rates and moves inversely to the prevailing interest rates. A cut in interest rate makes bond prices increase and vice versa.

Compared to any other category of debt funds, GILT Funds are highly volatile and you need to time your entry and exit to get maximised returns on investments. 

What Makes GILT Funds Highly Volatile?

GILT Funds have a higher average maturity and modified duration, which makes it highly sensitive to interest rate changes.

Average maturity is the weighted average of the current maturities of all debt securities held in the fund. Whereas, modified duration expresses the measurable change in the value of a security to change in interest rate.

Therefore, if the modified duration of the fund is 5 years, then it signifies that a per cent change in interest rate would change the value of the security by 5 per cent.

If we look at some of the GILT Funds, the modified duration of Nippon India Gilt Securities Fund is 6.47 years, SBI Magnum Gilt Fund is 8.22 years and DSP Government Securities Fund is 7.99 years.

Due to the higher modified duration, such funds tend to be highly volatile in the short term. For example, for SBI Magnum GILT Fund, the best week was between (19th Aug 2013 – 26th Aug 2013) with 6.24% gain and the worst week was 02nd Jan 2009 – 09 Jan 2009), when it lost 9.60%.

Similarly, for Nippon India Gilt Fund, their best week was between 11th Dec 2008 – 18th Dec 2008 with 6.83% gains and the worst week was between 14th Aug 2008 – 22th Aug 2008, with loss of 18.16%.

Clearly, for retail investors who have invested with an expectation of stable return and safety of capital, it is not possible to stomach such kind of volatility.

Still, if you are considering investing in GILT Funds, make sure your investment tenure matches with the portfolio maturity of the fund to fetch maximum gains. 

Role of Fiscal Deficit

The fiscal deficit is the gap between the revenue and expenditure of the government and the negative gap is usually financed through market borrowings. For GILT Funds, the lower fiscal deficit is the ideal situation as the government need to borrow less money and hence, we can see lower yields and higher Gilt prices in the future.

But, given the current situation due to pandemic, softening of monetary policy by RBI and government’s borrowing is likely to exceed the targeted estimate is likely to negatively affect the price of GILT funds in the future. As a thumb rule, every 10 basis point increase in the 10-year benchmark bond yield decreases the bond value by 5070 paise and vice versa.

Other Options

The corporate bond fund category and banking & PSU debt fund category are the perfect alternatives to GILT Funds.

Not only do they have a lower modified duration which helps to lower the interest rate risk but also invests in high rated credit paper which minimises the default risk. The returns are stable both in the short term as well as long term.