Mutual funds known as "Gilt Funds" solely invest in government securities. They are favoured by cautious and risk-averse investors who want to make investments under the cover of safe government bonds.
Investors are insulated from credit risk because gilt funds only invest in government bonds. The instruments in which these funds invest are backed by the government. Therefore, there is no default risk attached to these securities.
These funds' maturity profiles can vary. While others are medium or long duration, some may be short term. These funds carry interest rate risk, just like all other bond funds.
The Reserve Bank of India is contacted by the Indian government if it needs money (or loans) (RBI). The RBI serves the government as a banker in addition to being the top bank. After borrowing money from other organisations like banks and insurance firms, the RBI loans it to the government. The fund manager of a gilt fund subscribes to fixed-term government securities that are issued by the RBI in exchange for the loan.?
This gilt fund refunds the government securities at maturity in exchange for money. The combination of low risk and fair returns offered by gilt funds may be excellent for an investor. However, the movements in interest rates have a significant impact on the performances.? So, a falling interest rate regime would be the best time to invest in gilt funds.
Only government securities with medium- to long-term horizons are included in investments made by gilt funds. Therefore, these funds meet investors' requirements for security. They are not the same as bond funds because the latter could invest some of their assets¡ªwhich can be risky¡ªin corporate bonds. Gilt funds make investments in low-risk debt assets like government securities, which guarantees capital preservation and offers modest returns. A gilt fund offers greater asset quality than a standard equities fund despite having a lower return than it does. For those investors who are risk-averse and prefer to invest in government assets, it is sometimes seen as the perfect investment sanctuary.
Apart from this, it has some additional benefits too,
Government securities exposure- Some government securities are not directly accessible to retail investors. Individuals can only access these government securities by investing in gilt funds.
Low credit risk- As the government issued the underlying assets, gilt funds are thought to pose little to no credit risk. Risk-averse investors should consider investing in gilt funds because the government may never default on its debts.
Excellent results- Gilt funds have a reputation for offering modest returns with little to no risk. These funds are appropriate for investors with short- to medium-term time horizons.
Risk element- Due to the absence of credit risk, gilt funds are more liquid than corporate bond funds. The reason for this is because the government will always make an effort to fulfil its duties. However, interest rate risk is the main problem for gilt funds. When the interest rate environment is one of rising rates, the fund's net asset value (NAV) falls precipitously.
Returns- Gilt funds have the potential to produce returns of up to 12%. The returns from gilt funds, however, are not assured and very erratic due to shifts in general interest rates. Therefore, while interest rates are declining, it would be advantageous to invest in Gilt funds. Also, Gilt funds are anticipated to perform better than equity funds even during periods of general economic weakness.
Cost- In order to cover the fund manager's fee and other associated costs, gilt funds impose an annual fee known as an expense ratio. This is a portion of the typical asset under management for the fund. The maximum expense ratio for debt funds is 2.25%, as per SEBI guidelines. The investing approach used by the fund management, however, may have an impact on the running costs of a certain fund. For instance, using a dynamic method entails buying and selling securities in response to interest rate changes.
Finance goals- If medium-term wealth accumulation is an objective, investing in gilt funds to benefit from interest rate volatility might be a good option. When the overall capital markets are declining and one is looking for safe havens to generate short-term returns, gilt funds might be the best option.
Gain via tax- Gilt fund's capital gains are taxable. The holding period¡ªthat is, how long you continue to invest in a gilt fund¡ªdetermines the tax rate that will apply. A short-term capital gain is one that was released in less than three years (STCG). Long-term capital gains are gains realised after three years or more (LTCG). Investors will receive the STCG from gilt funds, and he should pay the income tax accordingly. LTCG tax, on the other hand, is a flat 20% with indexation benefits.
A few notable gilt funds include ICICI Prudential Constant Maturity Gilt Fund, UTI Gilt Fund, SBI Magnum Gilt Fund, ICICI Prudential Gilt Fund and Canara Robeco Gilt Fund.