When the Indian government requires funds or loans for undertaking strategic development programs, it discusses this requirement with the RBI. The RBI serves the government as the banker and principal lender. Therefore, after borrowing from other institutions such as insurance companies and banks such as SBI, the RBI loans money to the government. In exchange for the loan, the RBI issues fixed term government securities that are subscribed to by a gilt fund mutual manager. This gilt fund returns securities from the government upon maturity and receives money in return.
Gilt funds invest in central government and state governments fixed interest bonds. This money goes to building new infra and other government spending. The nickname gilt originates from gilded edge certificates. According to SEBI regulations, gilt funds have the mandate to invest at least 80% of their funds in government securities.
Gilt funds are a type of mutual fund that invests only in government issued bonds and securities called gsecs. These securities vary in maturity and are considered a risk free investment as the money invested is in the government’s securities only. Long and medium term government securities are selected for investment, and because the Reserve Bank of India (RBI) determines the interest on the same invested in, they are considered an option for low risk investments. There are two kinds of gilt funds. One of the types of gilt funds that invest mostly in government securities across various maturities. The second, gilt funds are with a fixed maturity of 10 years such funds need to invest at least 80% of their assets in government securities with a maturity of 10 yrs.
Gilt funds can be an ideal combination of low risk and fair returns for a mutual fund investor. Gilt funds are extremely dependent on interest rate movement movements as the government borrowing typically happens to be for a longer duration. The correct time to invest in gilt mutual funds would be in a declining interest rate regime as historically these mutual funds have increased in value the most during such regimes.
The gilt fund carries a return based on the RBI fixed repo rate. If RBI does not adjust the interest rate, investing in gilt funds will be a good time as these types of mutual funds offer fair and steady returns, making it an optimal choice for you to invest.
Gilt funds are capable of yielding up around 11 percent in declining interest rates. However with changes in overall interest rates, returns from gilt funds are not guaranteed and highly variable based on interest rates. Hence investing in gilt funds would be beneficial, if interest rates fall. Gilt funds are still expected to deliver higher returns than even equity funds when the economy as a whole is facing a recession.
Gilt funds are the most liquid investments, as they do not bear credit risk, unlike corporate bond funds. The reasoning is that the government may never fail to meet its obligations. Gilt funds, however, suffer mainly from interest rate risk. In an increasing interest rate regime, the fund’s net asset value (NAV) drops sharply, and this occurs because it leads to a rise in the fund’s underlying asset prices.
Mutual fund Investors need to assess their risk appetite before investing and then make an investment decision. The gilt funds are suitable for high security; and offer reasonable returns are for longer investment horizons. A gilt funds maturity is lower than other types of mutual funds. The tenure depends on the bond in which you invest. Don’t invest in the funds solely because of the government security or your mutual fund advisor or mutual fund distributor told you to invest but because these mutual funds are also a good opportunity to be a part of the Nation building process through investing while earning financial returns.
The information, analysis and opinions expressed herein are for educational purposes only and are not intended to provide specific advice or recommendations for types of mutual fund schemes. This material is not an offer, solicitation or recommendation to purchase any financial products or services or gilt mutual funds. Always remember that all investments, including gilt mutual fund investments carry some level of risk, including the potential loss of principal invested.