What are Gilt Funds
Gilt funds are a category of mutual funds that invest in government securities. These funds fall under the broader category of debt funds. To comprehend gilt funds, government securities need to be first understood.
A government security or simply G-Sec is a debt instrument that is issued by the Central Government or State Governments to generate funds for public expenditure. G-secs are issued through India’s central bank, the Reserve Bank of India (RBI). They are referred to as “gilt” as these do not have a default risk given their sovereign guarantee and rating.
There are broadly two types of G-secs:
- Short-term securities, such as treasury bills, have maturities of less than one year and are issued only by the central government.
- Long-term securities, like government bonds or dated securities, have maturities of more than one year and are issued by the central and state governments.
While we are now aware of the underlying portfolio of gilt funds, let us understand the size of this category.
Size of the Gilt Funds
The assets under management (AUM) of open-ended debt oriented schemes has reduced by approximately 12% from INR 14 lakh cr in February 2022 to INR 12 lakh cr in January 2023, whereas the AUM of the gilt funds saw a significant jump of about 68% during the same period.
To understand why there has been such a significant increase in the AUM of this specific category, let’s examine this category’s yield-to-maturity (YTM) movement to learn more about it.
Yield-to-Maturity Movement
The average YTM of gilt funds has increased by more than 32%, from 5.5% pa in February 2022 to 7.3% per annum in January 2023. One of the crucial reasons for this rise has been the increase in the repo rate by the Reserve Bank of India (RBI) to battle rising inflation. This has resulted in movement in the G-secs as well. Thus, you can see that the YTM of G-secs moves in sync with inflation.
During the last year, the repo rate has increased from 4% pa to 6.5% pa, which is an increase of 250 bps. Many investors prefer investing in a secured instrument which has a yield of over 7%. That has resulted in the increase in the assets under management (AUM) of this category of funds.
Risks Associated with Gilt Funds
Default Risk
A debt instrument carries a number of different kinds of risks. The default risk is the most important of them all. The likelihood that the borrower won’t make prompt and complete principal and interest payments is known as the default risk. Gilt funds are not exposed to this risk because being a government, which carries a sovereign rating, backs these securities. Corporate bonds typically come with this kind of risk.
Duration Risk
First, let us understand the relationship between the prices of debt instruments and their yields. Bond prices always have an inverse correlation with the interest rate movement. This means that if the interest rate increases then the price of bonds decreases, and vice versa. The sensitivity of the price of debt instruments to changes in interest rates is known as duration risk.
The duration risk, which typically applies to debt instruments with longer or higher maturities, is an additional risk. Longer-duration gilt funds have the highest duration risks since the maturities of gilt funds range from 90 days to more than 30 years. Longer-tenured gilt funds have greater duration risks but if the goal is to retain the bond to maturity, this risk is typically reduced.
Advantages of Investing in Gilt Funds
Liquidity
Like any other debt fund, by investing in G-secs through mutual funds, one need not worry about the liquidity of one’s investment, as mutual funds provide an easy exit option. Additionally; as the underlying portfolio of gilt funds comprises government securities that carry sovereign rating, the liquidity of these debt instruments is the highest amongst all debt instruments.
Access to Government Securities
The main participants in G-secs include banks and financial institutions. Their general market lot size deals amount to about INR 20 cr to INR 25 cr. By investing in Gilt mutual funds, one can participate in G-secs at a much lower amount. Moreover; if someone wants to invest in multiple government securities with a minimum investment amount, then they can consider Gilt funds as one of the best options for investment.
Returns
When the YTM is greater than 7% to 7.5%; the current returns tend to be low and vice versa. Here’s why: Consider a scenario wherein current returns are in the double digits, say 10%, whereas YTM is between 5% and 6%. Investing at this time would not be a prudent move, given the forward earnings represented by the YTM is lesser than current returns earned.
Security
Gilt funds provide access to the highest quality papers and hence do not have any credit risk.
Who Should Consider Investing In Gilt Funds?
Investors who seek exposure to debt instruments can look at investing in gilt funds as part of their asset allocation. This type of fund is also suitable for investors who are looking for safe investment options with zero risk tolerance for the principal amount. These funds are typically for investors who do not want to take any credit risk.
Types of Gilt Funds
There are three types of gilt funds in which an investor can consider investing:
- Gilt fund
This type of gilt fund invests in government securities that can have any maturity. For example, funds in this category can have exposure to short-duration papers, with maturities of 1-3 years, or they can position themselves to invest in papers that have durations of around 10–15 years.
As per SEBI’s mandate of categorization, this type of fund needs to have at least 80% of its portfolio allocated only to government securities. The balance 20% is generally invested by mutual funds in debt instruments like T-bills, cash and cash equivalent securities, certificate of deposit, commercial papers, among others.
- Gilt funds with a 10-year constant maturity
In this case, the funds have an exposure to government securities with 10-year durations. Similar to the above gilt und, as per SEBI’s mandate of categorization, this type also needs to have at least 80% of its portfolio allocated only to government securities.
- Target maturity index funds
In the last year, many funds have come out with target maturity funds. These have an exposure to only government securities, either central or state, with any maturity.
The maturity is, however, fixed. In terms of categorization, there is no mandate by SEBI in this category of funds, but the objectives specified by the funds are usually met. These are something like open-ended fixed maturity plans (FMPs).
How are Gilt Funds Taxed?
The tax treatment of the gains accrued from gilt funds is similar to those of any other category under debt mutual funds. The table below showcases the details of tax applicable:
