Hello Readers!
After the fiasco of Franklin Templeton Debt Mutual funds that happened due to an increase in the credit risk of these funds, many investors started shifting their debt allocation towards Gilt Funds.
As per them, Gilt funds are the safest fund when we compare funds on the basis of credit risk. But here the question is, does moving to gilt fund only because they are safe from credit risk, makes a sense?
Well, let us understand the gilt fund in brief.
What are Gilt Funds?
Gilt funds mainly focus its investment in Government securities (G-secs) issued by the RBI on behalf of the Government. It generally invests in high credit quality bonds, where capital protection is more or less guaranteed. These G-secs have a negligible risk of default (or credit risk), thus gilt funds are less risky when it comes to credit risk.
However, gilt funds carry other types of risks that investors need to be aware of before investing in it.
Risk in Gilt Funds
There are generally three kinds of risk associated with Debt funds, namely, Credit Risk, Liquidity Risk, and Interest rate risk. Credit risk arises when the default occurs in the repayments by the borrower, while liquidity risk is the inability to sell the financial securities easily in the market. And interest rate risk, in general, is the susceptibility of the bond prices to the changes in the interest rates in the economy.
Out of these risks, gilt funds invest in G-secs issued by the RBI on behalf of the Government, so generally, they have very low credit risk. When it comes to liquidity risk, low rated-bonds (AA or below) have higher liquidity risk than that of benchmark G-secs.
Gilt funds are more associated with interest rate risk. Under an increasing interest rate regime, the returns from gilt funds fall, and credit goes to the inverse relationship between bond prices and interest rates.
It has been analyzed that the higher the maturity of government bonds the more volatile their prices are. For instance, the price of a five-year government bond falls by five percent for every one percent increase in interest rates and vice-versa. Generally, Gilt Funds that hold a maturity period ranging from 5-10 years are highly affected by the interest rate movements in the market.
What do past returns say about Gilt Funds?
Well, the past returns of Gilt funds show that on average, it has given a return of 15.7 percent in the last one year, which is next only to that of Gold funds. The track record of gilt funds shows that in the last three, five, and 10 years, it gave a CAGR of 8.6 percent, 9.0 percent, and 8.7 percent respectively. That looks impressive and may attract investors towards Gilt Funds.
However only on the basis of good past returns, it can be announced that gild funds are a best bet for investors.
Does an impressive past return make it ideal for investing in Gilt Funds?
Interest rate movements in the market are not still, it goes up and down continuously. At this time, it is hovering at multi-year lows with higher odds of interest rates going up. With average maturity of G-sec holdings at 8.8 years for gilt funds, there are chances of gilt funds posting negative returns if interest rates rise consistently.
Thus, investors do not need to get attracted by the past returns offered by gilt funds, instead, they need to proceed with caution.
Goal orientation
As always said, while picking up a fund to invest always get it to sync with the financial goal in mind. Once you arrive at an asset allocation for it, you need to choose from various debt funds in the offering.
For your short-term investment requirement, you should look at other debt funds like liquid funds, ultra-short-term debt funds, and short-term debt funds. They have the ability to outperform the returns of Bank fixed deposits and protect capital.
Gilt funds do carry very minimal credit risk but at the same time, they are highly impacted by the interest rate risk. Thus, it is advisable to stick to liquid, ultra-short duration and low duration funds for your debt portfolio allocations.
For any kind of query, you can contact us at Shri Ashutosh Securities Pvt Ltd., we are here to help you in any way possible.
Happy Investing!
(Mutual Fund investments are subject to market risk Illustrations are for example only, there is no guarantee of returns. Past performance is not an indicator/guarantee to future returns).