Don’t turn a blind eye to gilt fund risks

While they offer protection against credit risks, they are susceptible to interest-rate risks

Of late, with portfolios of stocks and equity mutual funds bleeding overall, investors have turned their attention towards gilt funds which have posted stellar returns over the past year. The number of investor accounts in gilt funds have significantly grown to 102,940 in July 2019 from 80,233 in May 2019.

While the Nifty Midcap and the Nifty Smallcap indices were down 15 per cent and 26 per cent, respectively, in the past year, gilt funds, on an average, yielded returns of around 15 per cent. Many investors have rushed into investing in gilt funds without understanding the risks involved in such schemes.

Gilt funds are mutual fund schemes that invest predominantly in government securities (G-Secs), State development loans (SDLs), T-Bills, repo and Tri-party repos.

Individual investors are allowed to participate in the G-Sec market with a minimum investment amount of ₹10,000 through the NSE. But investing directly in G-Secs is not easy as trading volumes in the retail segment are currently quite low, and exiting is difficult. Gilt funds offer such investors a convenient means to indirectly invest in G-Secs.

Returns from these schemes are inversely proportional to the movement in interest rates. Apart from interest-rate changes, gilt funds are impacted by other economic factors, the expected rate of inflation and the liquidity situation. Policy actions by the RBI also affect the NAV of gilt funds. Developments in international bond markets, specifically the US Treasuries, also affect prices of G-Secs in India.

Investors can benefit from gilt funds as they offer good diversification to the investors’ overall portfolio. Gilt funds also provide a much needed stability to one’s portfolio, especially when the economy goes through a recession or a slack phase.

However, one should not turn a blind eye to the risks involved in gilt funds, particularly interest-rate risk or duration risk. When interest rates rise, gilt fund NAV falls, and vice-versa. Returns could be highly volatile and there is a chance of periods of negative returns as well.

While gilt funds offer protection against credit risks, they are susceptible to interest-rate risks. They require tactical calls by investors based on their expectation of interest-rate movements in the future. Timing is a crucial aspect to do well in these funds, or one can do SIP in these funds.

Before you invest

In the current scenario, where the RBI has cut the repo rate four times successively, recent returns from gilt funds have shot up. Returns that new investors expect based on the recent returns may not be achievable in the near term.

Investors planning to get in now would be entering at the peak or near peak of 10-year G-Sec prices, which would impact their future returns adversely.

However, investors can consider allocating 5-10 per cent of their MF portfolio value in gilt funds (through SIP) with a long-term horizon of at least three years. Within gilt funds, constant maturity funds are also an interesting option.

The writer is Head - Retail Research, HDFC securities

Published on August 11, 2019
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