Investing in gilt funds can be a wise choice if you are a long-term investor ready to invest in high-quality debt instruments with low credit risk. Gilt funds are a type of debt mutual fund that consist only of fixed-income investments issued by the central or state governments.
What is a gilt fund?
Gilt funds solely invest in government securities and are hence favoured by cautious and risk-averse investors. According to regulations by the Securities and Exchange Board of India (SEBI), gilt funds are required to invest at least 80% of their assets in government-issued securities.
Unlike bond funds, gilt funds only invest in high-quality, low-risk Government Securities (G-secs), typically considered safe investments with a AAA rating. Although the returns may be lower than those of other asset classes like equity, the strong asset quality guarantees that investors’ funds are well guarded against capital risk.
Gilt funds are taxed as other debt mutual funds since they invest their assets in government-issued debt securities. The gains from the units redeemed within 36 months are taxed as Short-Term Capital Gains (STCGs) and are added to the investor’s annual income and taxed according to their income tax bracket. While the gains units redeemed after 36 months are subject to Long-Term Capital Gains (LTCGs) tax at a rate of 20% after indexation.
Benefits of gilt funds
- Low credit risk
Unlike debt funds, gilt funds are not exposed to credit risk. You need not be concerned about the credit quality of the underlying securities because they come with the sovereign guarantee of the Government of India. The Indian government owes the interest on these debt securities.
- Exposure to government securities
Sometimes gaining access to certain types of government securities is not easy. However, by investing in gilt funds, you can obtain quick exposure to government securities you would not otherwise have.
- Long-term investments
The average maturity of most gilt fund portfolios is seven years currently. This makes them a great investment option for investors with long-term horizons of five years or above who want to invest in the debt asset class.
Returns of gilt funds
Gilt funds have a reputation for offering modest returns with little risk. Gilt funds, however, can generate returns of up to 7% to 9% or higher depending on the interest rate environment in the country. Gilt funds are highly sensitive to changing interest rates and returns from gilt funds are not guaranteed. When interest rates are dropping, or the economy is struggling, returns offered by gilt funds are higher.
Things to consider when investing in gilt funds
- If interest rates rise, the NAV, or net asset value, drops significantly.
- As interest rates fluctuate throughout the year, the returns from the gilt fund are unpredictable.
- Taxes must be paid on capital gains from investments in gilt funds.
- Gilt funds carry an expense ratio to cover costs such as fund management fees.
In conclusion, risk-averse investors with a medium to long-term investment horizon tend to favour gilt funds. For diversification of your mutual fund portfolio or your debt portfolio, gilt funds can be a great option.