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What Are Gilt Funds & Should You Invest in Them?

Know the meaning of Gilt Funds, how they work and common investment risks.

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In India, debt funds are often the preferred investment of conservative investors who seek to make short-term investments in relatively low risk mutual funds. However, some investors might be seeking long term debt investments in mutual funds while benefiting from changes in market interest rates. Gilt Funds can be a suitable investment for such investors. Read on to find out what gilt funds are, what they invest in and benefits as well as limitations of investing in this type of mutual fund. 

What are Gilt Funds? 

Gilt funds can be defined as a unique type of debt mutual fund that almost solely invests in government bonds or G-Secs. G-secs or Governments securities are sovereign papers issued by the Government of India so investors are not subject to minimal credit risk with respect to the principal amount invested.

But like other mutual funds, gilt funds are not risk-free and also do not offer assured returns. Typically, G-secs can have a long maturity period often up to 10 years or 20 years. This increases the potential for interest rate risk of the investment. So, when market interest rates increase, the price of these bonds will decrease while a decrease in market interest rates leads to an increase in the price of government securities. As, a result, returns from Gilt Funds feature an inverse correlation to interest rates and carry a high degree of interest rate risk.     

How do Gilt Funds Work?

The Reserve Bank of India (RBI) is consulted whenever the state or central government needs money. RBI gets the money it needs from banks and insurance companies and then lends it to the federal and state governments. 

In return, the Reserve Bank of India issues G-secs or fixed-return government securities with a pre-determined maturity period of usually 10 years. Subscribers to these securities include Gilt Funds. However, Gilt Funds are not required to hold G-Secs till maturity and individual securities can be traded on bond markets. For most cautious investors, Gilt funds offer the ideal balance of decent returns and low risks. It is crucial to remember, though, that fluctuations in interest rates can impact the performance of Gilt Funds.

Who Should Invest in Gilt Funds 

Gilt funds are considered suitable for those that prioritize security above high returns and are seeking to stay invested for longer periods usually 3 years or longer. Historically, over the medium to long term, gilt funds have provided a good balance between capital preservation and reasonable returns. In addition, it offers superior asset quality of the underlying investment in comparison to equity funds and even many debt funds. These work well when markets are plummeting. High gains are provided by interest rate volatility, but the fund is also subject to interest rate risk.

Factors to Keep in Mind Before Investing in Gilt Funds 

When choosing to invest in the best Gilt funds, investors must consider various criteria. The following is a discussion of some of the crucial elements.

  • Interest rate risk:

As previously noted, risk-cautious investors might consider investing in Gilt funds due to the potentially low credit risk of the underlying bonds issued by the government. But these debt funds are highly susceptible to changes in interest rates. Investors must therefore consider this risk carefully before investing.

 

  • Investment Expense:

The expense ratio is the phrase used to describe the investment cost for Gilt funds. The fund's expenditure ratio includes the fund manager's fees and other management expenses, including administration fees. The average assets under management for the fund is how this expense ratio is calculated. As per SEBI norms, the top ceiling for the expense ratio for debt mutual funds is set at 2.25%.

  • The Investment Goal:

The investor's investing goal is another crucial consideration. These funds are perfect for investors who aim to grow their money over a reasonably long period. In addition, these funds assist investors in navigating interest rate swings and offer risk-free investing opportunities while protecting their initial capital investment.

  • Investment Duration:

The investment horizon for Gilt funds ranges from three to five years. This investment time frame is shorter than more conventional long-term investments, such as those lasting 5 years or longer. However, it is recommended that an investor stays invested over the long term in order to maximize the potential benefits from multiple interest rate cycles.

 

Common Risks of Investing in Gilt Mutual Funds 

  • Gilt fund returns are subject to interest rate risk i.e. they are impacted by periodic changes in interest rates. The inverse relationship between bond prices and interest rates may impact the returns on Gilt funds
  • While investing in government securities through Gilt funds is safe and secure, it is not as liquid as a liquid fund or an ultra-short duration fund. In addition, switching between government bonds is challenging.
  • Cost-wise, management fees for Gilt funds are capped by SEBI at 2.25% of the NAV. Therefore, investors should exercise caution while selecting a fund.
  • Investment horizon: Government bonds with medium- to long-term maturities are purchased by Gilt funds. This portfolio's average maturity usually ranges between three to five years.
  • While investing in government securities through Gilt funds is safe and secure, it is not as liquid as a liquid fund or an ultra-short duration fund. In addition, switching between government bonds is challenging.
  • Cost-wise, management fees for Gilt funds are capped by SEBI at 2.25% of the NAV. Therefore, investors should exercise caution while selecting a fund.
  • Investment horizon: Government bonds with medium- to long-term maturities are purchased by Gilt funds. This portfolio's average maturity usually ranges between three to five years.

How are Gilt Funds Taxed? 

Taxation rules of mutual funds impact the potential returns that one might get from Gilt Fund schemes. For various tenures of investment holdings, the taxability of Gilt funds is as follows:

  • The returns from Gilt funds are regarded as Short-Term Capital Gains (STCG) for taxable reasons if the units are redeemed within a 36-month window. These gains are taxed at the investor's appropriate income tax rate.
  • The returns on investments are considered Long Term Capital Gains (LTCG) for tax purposes if the units are redeemed after the initial 36-month holding term. For gilt fund investments made before 1st April 2023, the gains are taxed at a rate of 20% with indexation benefit. For gilt fund units bought after 1st April 2023, long term capital gains on returns will be as per the applicable income tax slab of the investor.

Conclusion 

India's Gilt funds have been performing positively due to decreasing interest rates. For Indian investment trusts, Gilt funds have produced returns in the two-digit range. However, the interest rate can fluctuate greatly, leading to poor returns. Though investors in Gilt funds should exercise caution, overall, Gilt funds are thought to be secure investments.

Frequently Asked Questions (FAQs)

Q. What does the term "Gilt funds" mean? 

A fund that invests almost exclusively in fixed-income securities i.e. bonds issued by the central and state governments is known as a "Gilt fund."

Q. Are Gilt fund investments safe? 

Because they invest in the government, Gilt mutual funds are regarded as secure.

Q. Can I ever withdraw my Gilt funds? 

No. Only at maturity are the returns and gains eligible for withdrawal.

Q. Can I make both systematic and lump sum investments in Gilt funds? 

Yes. Both systematic investment plan and lump sum investments are allowed in gilt funds unless the fund manager restricts fresh investments in the scheme for any reason.

Q. What is the debt fund's maximum expense ratio? 

SEBI has fixed a maximum expense ratio for debt mutual funds including gilt funds at 2.25% annually.

Sources:

https://economictimes.indiatimes.com/mf/analysis/best-Gilt-mutual-funds-to-invest-in-2022/articleshow/88580839.cms?from=mdr

https://www.forbes.com/advisor/in/investing/gilt-funds/

https://www.5paisa.com/stock-market-guide/mutual-funds/what-is-Gilt-fund

https://zfunds.in/m/Gilt-funds

https://www.fisdom.com/Gilt-funds/#FAQs

https://economictimes.indiatimes.com/definition/Gilt-funds

https://scripbox.com/mutual-fund/Gilt

ARN No : May23/Bg/08

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