The Hindu Business Line : ICICI Prudential Gilt Fund: Invest

With inflation sliding more quickly than expected and interest rates declining across the world, the pressure continues to build on Indian policymakers to cut rates further.

The clear signals of softening interest rates over the medium term have led to a sharp fall in bond yields and rising bond prices. That makes it an opportune time to invest in gilt funds.

An investment in ICICI Pru Gilt Investment Plan can be considered based on its performance since inception.

The fund has generated an annualised return of 12.2 per cent since its inception and this period spans varying trends in the interest rate cycle. Investors may consider the fund as an option to add to their debt portfolio.

A conservative investor might find the liquidity of the fund and the sovereign guarantee that backs its securities attractive.

Those in the higher tax brackets may also find it a tax efficient way to earn debt returns. However, for an investor whose income is within the tax bracket, FD appears to be a superior choice if one is acceptable to locking up the funds till maturity.

For those in the higher tax bracket, capital gains with or without indexation on the Gilt Fund can help achieve higher yields compared to pure fixed deposits.

Performance: The fund has consistently outperformed the benchmark I Sec I-Bex by a comfortable margin over different cycles in interest rates.

Even as equity markets were struggling to generate a positive return, ICICI Pru Gilt has piggybacked on rising gilt prices to generate a return of 25.3 per cent over a one-year period.

A major part of this return has been achieved during the past few months, amid the sharp slide in yields.

Though returns of this order may not be repeated, returns are likely to remain healthy (in the 10-11 per cent range) over the next one year, given the softening bias to interest rates.

Portfolio: According to the November portfolio, the fund had 86 per cent in long-term bonds (above 10-year maturity), 3 per cent in CDs and term deposits and the balance in money markets and other assets. The preference for long-dated securities, reflected in the 10-year yield-to-maturity, has dropped from a high of 9.5 per cent to 6.7 per cent.

The softening of inflation and the anticipated cut in interest rates have pushed down yields and helped prices of long-term bonds over the past six months. Funds with a longer average maturity have obviously registered sharper gains from this trend than those with a shorter maturity. A flight to safety has also helped widen the spread between gilts and corporate bonds.

However, investors now have to actively consider the risk associated with the long-term bonds before investing in them: For one, though they are debt oriented funds and are free from credit risk, gilt funds do expose investors to price risk – the risk that yields may spike, hurting NAVs. For instance, in the past three months, a period of falling interest rates, the fund’s NAV has grown by 17.4 per cent (absolute). In the calendar year 2004, a period when interest rates began their ascent, the fund managed a return of just 0.2 per cent. This gives a fair idea of the possible volatility in the fund.

A lower- than-anticipated correction in inflation or decline in interest rates, are risks to the fund’s NAV at this juncture.

But given the global economic situation and considerable slowdown in the country’s economy, interest rates do appear unlikely to go up in the near future, which can limit the risk.

According to the fund manager, the fund intends to hold 70 per cent of the assets in long term instruments and 25-30 per cent will be churned to generate higher yields.

With the interest rate heading south, ICICI Pru Gilt Investment has a potential to generate better returns.

Fund facts: The fund, launched in August 1999, is managed by Mr Rahul Goswami. The minimum investment is Rs 25,000. The fund charges no entry or exit loads for the investment.

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