Gilt Mutual Funds

What are Gilt Funds?

Gilt funds are open-ended debt mutual fund schemes that invest at least 80 per cent of their assets in government securities (G-Secs) across maturity. These funds are considered relatively low-risk investments because they invest in securities backed by the government, generally considered to have a lower default risk than corporate entities.

A G-Sec is a tradable instrument issued by the Central or State Governments. It acknowledges the Government’s debt obligation. Such securities are short-term (usually called treasury bills, with original maturities of less than one year) or long-term (usually called Government bonds or dated securities with original maturity of one year or more).

In India, the Central Government issues both treasury bills and bonds or dated securities, while the State Governments issue only bonds or dated securities, called the State Development Loans (SDLs). G-Secs carry practically no risk of default and, hence, are called risk-free gilt-edged instruments.

The term "gilt-edged" historically referred to high-quality bonds, often government bonds. These certificates sometimes featured gilded (gold-coloured) edges as a visual mark of their safety and reliability.

As of April 2024, this fund category has average assets under management (AUM) of Rs 29,910.96 crore with 21 schemes, with the oldest being more than 25 years old, and the category ranked 11th in the list of open-ended debt funds according to the Association of Mutual Funds in India (AMFI).

Source: AMFI website as of April 2024

While you should identify your risk profile and plan your financial goals before investing in gilt funds, here are some situations where they may fit in

Alternative to Bank Fixed Deposits

As of April 2024, the annual return for gilt funds is 5.78% to 8.82%. On the other hand, interest rates offered by large banks range between 6.6% to 7.1%. You can see that they give you better returns than bank fixed deposits, although they are market-linked and can fluctuate.

Source: Valueresearch, SBI, HDFC Bank, ICICI Bank, BOB websites

Note: While gilt funds are good alternatives to bank current and savings accounts, they are not insured like them. Up to Rs. 5 lakh per bank account are insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC).

Conservative Investors

Those seeking the safest possible fixed-income investment option. The sovereign guarantee backing government securities makes gilt funds ideal for minimising credit risk.

Income-Oriented Investors

G-Secs that gilt funds invest in provide regular interest payments, typically semi-annually. This creates a reliable stream of income for investors.

Anticipated Interest Rate Decline

Investors who believe that interest rates in India will likely fall shortly could benefit from investing in gilt funds. Falling rates tend to boost bond prices, potentially leading to capital gains.

Short to Medium-Term Financial Goals

If you're saving for a goal a few years away and prioritise capital protection over maximising returns, gilt funds with suitable maturities could be a good fit. G-Secs offer a high degree of safety due to the sovereign guarantee minimising the risk of losing your principal investment, a crucial factor for short to medium-term goals.

Dividend Taxation

These funds pay out dividends when you invest in their IDCW (Income Distribution Cum Withdrawal) option. Dividends are taxed at your marginal income tax rate, and TDS (Tax Deducted at Source) at 10% applies to dividends received more than Rs 5,000 per AMC per financial year.

Gilt funds offer a range of benefits, as shown below.

High Safety

G-Secs in India carry the government's backing, making default highly unlikely. Gilt funds provide this high degree of safety for your investment.

Potential to Benefit from Interest Rate Trends

Gilt fund prices can increase if the Reserve Bank of India (RBI) lowers interest rates, leading to potential capital gains. Gilt funds allow Indian investors to strategically position their portfolios to benefit from expected interest rate changes.

Reliable Income

G-Secs offer fixed interest payments, which gilt funds pass on to investors, creating a consistent income stream. This especially benefits Indian retirees or investors seeking a predictable income source to supplement other investments.

Portfolio Stability and Diversification

Gilt funds can add stability to an Indian investor's portfolio that might be heavily focused on equities, reducing overall risk exposure. During stock market uncertainty, gilt funds can offer protection due to their lower correlation with equities.

Disadvantages of Gilt Funds

Gilt funds also face some drawbacks, as shown below.

Interest Rate Risk

Gilt funds have an inverse relationship with interest rates, and if interest rates rise, the prices of the bonds within the gilt fund can decline, leading to a potential decrease in the fund's value. Gilt funds investing in longer-term government securities are generally more sensitive to interest rate changes than those focused on short-term bonds.

Limited Growth

Gilt funds prioritise capital preservation and income generation. They are not designed for aggressive wealth building or delivering high returns.

Inflation Risk

Gilt funds may not provide effective protection against inflation. If the inflation rate exceeds the returns generated by the fund, investors may experience a decline in real purchasing power.

Dependency on Government Policies

Gilt funds are influenced by government policies, fiscal measures, and borrowing patterns. Changes in these factors can impact the performance of the fund.