Gilt Mutual Funds – Concept, Workings, Features, Types, Benefits & more

In this article we will understand what Gilt Mutual Funds are, what they invest in as well their advantages and disadvantages.

Investors tend to opt for debt mutual funds as they offer stable and reasonable returns with lower risk as compared to market linked equity funds.

The risk susceptibility however differs within different types of debt mutual funds. This depends on the investment strategy and the type of debt securities that it invests in. 

One such category of debt funds, ‘Gilt mutual funds’ carry the lowest risk within debt mutual funds.

About Gilt Mutual Fund

A gilt mutual fund is a mutual fund that invests predominantly in debt securities of the government. These may be of the central government or of any state government. 

The fund can invest in such securities across different durations. These securities are called ‘Gilt securities’ or ‘G-sec’.

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What are Gilt Securities?

The Reserve Bank of India (RBI) is the central banker of the country.

It works as the banker to central and state governments. When any government (central or state) is in need of funds, it approaches the RBI. 

They may need these funds for any of its social objectives such as infrastructure building etc.

The RBI in turns collects money from lenders such as other banks or insurance companies. 

In return, the RBI, on behalf of the Government Issue debt securities with fixed coupon rate and maturity date. These debt securities issued are called as ‘gilt securities. 

It is the obligation of the borrowing central or state government to honour the payment of these gilt securities.

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How does Gilt Funds work?

Gilt mutual funds invest its corpus in these gilt securities. They may invest in gilt securities of varying duration depending on the interest rate scenario. 

Since these gilt securities are to be honored by the government, they enjoy sovereign status and carry practically no risk.

The objective of these funds is to earn reasonable returns for its investors along with capital protection. 

The fact that the funds are subject to practically no credit risk ensures that the capital is protected. The fund however is subject to interest rate risk due to likely volatility in interest rate market.

Key Features of Gilt Mutual Funds

Check out the major features of Gilt Funds here –

No credit risk

As gilt mutual funds invest in debt securities issued by the government, they have practically no risk of default. 

As the government guarantees payment against these securities, they enjoy sovereign status. This ensures complete capital protection for the investors. 

Thus, they have practically no credit risk. This distinguishes them from other debt mutual funds.

Susceptibility to interest risk

Although gilt mutual funds do not have any credit risk, they are subject to interest risk. If market interest rates begin to rise, the value of these funds holding securities of lower coupon rates is likely to fall. 

Thus, volatility in interest rates can adversely impact the valuation of the this funds.

Return potential

The objective of gilt mutual funds is to earn moderate returns for its investors. Apart from the returns from coupon rates of the debt securities they also have the potential for capital growth. 

In a falling interest scenario, the value of the gilt securities will increase. This increases the potential for higher growth for the gilt funds.

Varying duration

Fund managers of these mutual funds can invest in securities of varying duration. They can opt to invest in long term securities or short-term securities or a combination of both. 

This depends on the fund manager’s outlook on the interest rate scenario. If he envisages a fall in interest rates, he can prefer long term securities.

Whereas, if he believes interest rates will rise, he can prefer short term securities.

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Types of Gilt Mutual Funds

There are primarily two types of gilt mutual funds based on their duration

Long term gilt funds

Governments often issue securities that have a long-term period i.e.: they may have anywhere from 5 to 30 years till maturity. 

This is primarily because of the high value of these securities issued. Funds that invest in long term government securities are long term gilt funds.

Short term gilt funds

These funds may also invest in government securities that come with shorter maturity time frames. Such funds are short term gilt funds.

Taxation of Gilt Mutual Funds

Investors are taxed on gains on gilt mutual funds only at the time of redemption. The taxability depends on the holding period of the investor.

 If the fund is held for less than 3 years, then it qualifies as short-term capital. This gain is taxed at the slab rate applicable to the investor. 

On the other hand, if the investor holds the fund for more than 3 years, the gains are taxed as long-term capital gains.

These gains are taxed at a beneficial rate of 20%, after considering the effect of indexation.

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Who should invest in Gilt Mutual Funds?

As gilt funds have no credit risk, your capital is completely secure. Thus, these funds are suitable for investors who have low risk appetite and want surety that their investment is safe.

The returns from these funds however are not guaranteed and vary with variation in market interest rates. 

Thus, investors who are comfortable with earning moderate returns that may vary from time to time can opt for these funds.

Things to consider before Investing in Gilt Funds

Apart from the above characteristics, investors must consider the following factors while looking at gilt mutual funds:

Expense ratio

Like all other mutual funds, even they charge an annual fee for managing the fund. This is called ‘expense ratio’ and is expressed as a percentage of the assets under management of the particular fund. 

Expense ratio charged will be a cost for investors and reduce their return on investment.

Investors should thus check on the expense ratio being charged by the fund house and prefer a fund which charges a comparatively lower expense ratio.

Investment objective and time frame

Government issues securities typically for medium to long term. This means that they generally take minimum of 3 to 5 years to mature. 

Furthermore, they are subject to interest risk and thus a medium to long term duration would be preferred to absorb this risk. 

Investors should thus consider these funds if their investing horizon is at least 3 to 5 years.

Benefits of choosing Gilt Mutual Funds

Here are the list of major benefits of Gilt Mutual Fund –

No risk of default

The issuing government guarantees the payment of their securities, thus gilt mutual funds are not subject to any credit risk. Therefore, there is no risk of default of payment for the investors.

Better returns in the form of capital growth

The valuation of gilt mutual funds change with changes in market interest rates. In case the market rates are falling, the value of the these funds which have invested in higher coupon securities will increase.

In this way well managed gilt mutual funds can earn higher returns for its investors.

Pathway to invest in government securities

Central or state governments generally issue securities for high value amounts. This makes it difficult for small, retail investors to directly invest in them. 

These mutual funds give investors access to these risk-free securities even with minimal investment amounts. 

Disadvantages of Gilt Mutual Funds

Here are few drawbacks of investing in Gilt Funds –

High interest risk

While gilt mutual funds can potentially earn high returns for investors due to its inverse relationship with interest rates, there is also a flipside to this. This is interest risk. 

In case market interest rates increase, gilt funds having invested in lower coupon securities will see a fall in their valuation. Thus, there is a risk of loss of value for investors of this funds.

Liquidity crunch

Gilt securities are not as freely traded in the market as other securities such as corporate bonds. 

This can put liquidity pressure on fund managers of gilt mutual funds. This may also prevent them from switching in and out of securities of different durations.

Gilt Mutual Funds – Conclusion

All in all, gilt mutual funds are good for investors looking to earn moderate returns with capital protection.

The performance of gilt mutual funds depends considerably on interest rate volatility. 

In fact, there have been several years in which gilt fund have even earned double digit returns. This happens when interest rates have seen sharp and steady decline. 

Thus, these funds do have the potential to earn high returns in the right market scenario while offering complete capital protection to its investors.

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