While investing in debt funds is less risky than equity, investors should still be wary of the two main types of risk that can affect returns – interest rate and credit risk. Interest rate risk is the possibility that rising rates will reduce the fund’s value, and credit risk is the risk that the issuer of the bond may default on payments. The majority of the assets held by gilt funds are invested in government securities, which essentially reduces the credit risk to nil. Here, we’ll take you through all you need to know about these funds – from gilt fund meaning to how they are taxed and when you should invest in them.
Understanding Gilt Mutual Funds
So, what is a gilt fund? According to SEBI, a gilt fund is an open-ended debt scheme investing a minimum of 80% of its total assets in government securities (also called G-secs) across different maturities. These securities are issued by the central and state governments (SDLs), which makes them highly secure and free from credit risk.
They are one of the 16 debt mutual funds defined by SEBI under its fund classification structure. Since they invest only in government-backed instruments, they are especially suited for conservative investors looking for stable, safe returns. Like other debt schemes, gilt funds can also be impacted by changing interest rates.
As it is often confusing for many individuals, it’s important to clarify that “gilt” is not an acronym, therefore gilt full form in mutual fund investments doesn’t exist. It is a term borrowed from British finance, where “gilt-edged” refers to the certificates of government bonds. That’s why this term is used in Commonwealth countries like India and South Africa.
Simply put, gilt funds meaning can be understood as funds which invest mainly in debt instruments issued by the central or state government. Like an equity fund invests mainly in shares, a gilt fund invests in government bonds.
How do Gilt Funds Work?
Government securities like bonds are issued by the Reserve Bank of India when the government needs to borrow money for a variety of reasons like funding its expenses, financing infrastructure projects, or managing fiscal deficits. On the government’s behalf, the RBI creates these securities, which are then bought by financial entities like banks, insurance companies, mutual funds, and even individual investors. These securities come in many forms such as treasury bills (for short-term borrowing) and government bonds (for mid- to long-term borrowing).
The government pays regular interest on them and as they mature, it repays the principal to the investors. Since these instruments are fully backed by the central or state government, the chances of default are extremely low, making them some of the safest investment options if you’re looking to invest in the debt market.
In gilt mutual funds, fund managers buy these securities based on fund objectives and prevailing interest rates. As gilt funds invest in G-secs, the risk of default is pretty much zero. However, the same cannot be said for risks posed by fluctuations in interest rates. The fund is actively managed meaning the manager adjusts the portfolio by changing the maturity profile or selecting different types of government securities to optimise returns and balance interest rate risk.
As interest rates rise, the value of the bonds held by the fund goes down because the newly issued funds offer better interest rates. Similarly, when the interest rates fall, the existing securities in the fund’s portfolio become more valuable. Fund managers take advantage of these movements and balance risk and returns.
Key Features of Gilt Mutual Funds
Here are some aspects of gilt mutual funds you should be aware of before investing in them:
1. Low-Risk Investments
When gilt fund managers buy a G-sec, they are essentially loaning out money to the government. Unlike other debt funds which also invest in corporate debt or non-government debt, gilt funds are exclusively invested in government securities. This makes the credit risk zero because the borrower is the government itself. Gilt funds are thus an ideal option for risk-averse investors who prioritise safety and capital preservation.
2. They Carry Interest Rate Risk
Like other debt mutual funds, gilt funds are impacted by interest rate movements. A gilt fund’s interest rate sensitivity can affect the fund’s NAV. When interest rates fall, it’ll deliver higher returns. Conversely, when rates rise, returns will likely dip.
3. Diversification And Professional Management
Investing in a basket is always better than investing in securities individually. Gilt funds invest across different maturities to manage interest rate risks and cash flows. An investment in an individual long-term bond can be more vulnerable to interest rate changes because if rates rise, the bond’s price can fall significantly. Over a period the inflation can also fluctuate, and interest rates and inflation have a well-known relationship.
The best part is that you can leave these investing decisions to a professional fund manager. Instead of trying to time the market or track inflation trends yourself, you can rely on an expert who actively manages the fund based on the current and expected interest rates. You can also conveniently start investing in a gilt fund through an SIP.
4. No Lock-In Period
Gilt funds are open-ended, so you can redeem your units at any time you need. Some funds may charge an exit load in case you redeem before a specific period, so check the scheme information document or consult advisor financial services to understand any charges or exit conditions before investing.
Types of Gilt Funds
According to SEBI, out of the 16 types of debt mutual funds, there are two varieties of gilt mutual funds available:
1. Gilt Funds
These are the funds we’ve been talking about so far. A standard gilt fund is open-ended and invests a minimum of 80% of its total assets in government securities of varying maturities. The fund manager can invest in both short-term and long-term bonds, depending on how the market looks.
2. Gilt Funds With A 10-year Constant Duration
This is a special kind of gilt fund. It also invests at least 80% of its assets in G-secs, but the manager is required to maintain an average portfolio maturity of 10 years at all times. These funds are more sensitive to interest rate movements.
Benefits of Investing in Gilt Funds
1. Minimal Default Risk
Since the majority of the investment is made in G-secs, the risk of default is zero. These securities are backed by the Government of India, which makes gilt funds one of the safest fixed-income options available in the market. If you buy corporate bonds you need to assess the credit quality of the issuer, which can also fluctuate. Gilt funds eliminate credit risk entirely.
2. No Lock-in Period
Investing in G-secs individually can expose you to liquidity risk. When you need to sell before maturity and can’t find a buyer, you can run into trouble as the primary platform, RBI Retail Direct, is still new. With gilt funds, this issue is resolved. They are open-ended schemes so you can enter or exit anytime, subject to minimal or no exit load depending on the fund.
3. Good Returns
Even though gilt funds don’t offer fixed returns, they can significantly benefit from falling interest rates. When interest rates drop, the prices of government bonds rise, which leads to higher NAV. During such cycles, some of the best gilt funds can even outperform other categories of debt mutual funds.
4. Portfolio Diversification With G-secs
If you want to balance the equity component in your portfolio with debt, you can consider gilt funds as not only can you invest in them conveniently, but they are among the safest debt funds available in the market. Taking expert opinions on asset allocation from a finance advisor can help you determine how much exposure to gilt funds is right for your financial goals and risk appetite.
Who Should Invest in Gilt Funds?
If you’re asking yourself, “should I invest in gilt mutual funds?”, this should help you out. These funds are best suited for conservative investors who are looking for stable, low-risk returns over the medium to long term. Since gilt funds primarily invest in government securities, they carry zero credit risk, making them an attractive option for those who want to preserve their capital. Investors who:
- Want a safer alternative to debt funds investing in corporate bonds,
- Expect interest rates to drop, and
- Need a complementary asset in their portfolio for diversification
can all benefit from adding gilt funds to their financial strategy.
Things to Consider as an Investor
1. Risk
Interest rate changes heavily influence the value of a gilt fund’s underlying securities. If the interest rates rise the fund’s NAV can go down and vice versa. To mitigate this risk, managers diversify the fund’s portfolio across maturities and constantly monitor the interest rate and inflation situation to make the best possible decisions.
2. Returns
When the interest rates are falling, gilt mutual funds returns can be quite attractive for the level of risk they take. You can connect online with our expert financial advisor in Mumbai to understand whether this is the right time to invest in gilt funds based on your personal financial situation.
3. Tax
Gilt funds are taxed like any other debt mutual fund. And thanks to a major rule change in April 2023, taxation has become simpler. Now, all capital gains, regardless of the holding period, are added to your income and taxed as per your applicable tax slab. The removal of indexation benefits for holding the funds for longer has made taxation less favourable for long-term investors.
Dividend income earned from IDCW gilt funds is also taxable according to your tax slab. The AMC will deduct a 10% TDS in case this income exceeds Rs. 5,000 in a financial year.
4. Expense Ratio
The AMC charges a small fee called expense ratio to cover expenses. You should ideally compare the expense ratios across different gilt funds to make more optimal decisions.
5. Personal Considerations
You should always make sure your unique goals, situation, risk tolerance, and investment horizon align with any potential investment opportunity before committing.
How to Invest in Gilt Funds?
Just like any other fund, you can invest in gilt mutual funds either through a lump sum amount or via a Systematic Investment Plan. Both modes have their benefits. Lump sum investments are suitable when interest rates are expected to fall, while SIPs can be used when you are more comfortable with making regular, fixed contributions. They also help average out the investment cost through rupee cost averaging and reduce timing risk.
After you’ve chosen a suitable gilt fund, you can invest in it directly through the AMC’s website or a trusted platform. However, before making that commitment, it’s highly recommended to consult a qualified investment advisor. By working with one of our experienced advisors, you’ll receive personalized guidance tailored to your financial goals, risk tolerance, and circumstances.
We won’t just recommend funds, we’ll help you understand how to invest in gilt funds, whether they’re suitable for your needs, and how they fit into your investment strategy. Not only will we eliminate the hassle of researching and investing on your own, but we will also provide:
- Clarity on tax implications,
- Answers to your concerns like risk, returns, and timing,
- Portfolio monitoring, recommendations, and adjustments when needed,
- Guidance to ensure you stay on track to achieving your financial dreams!
Strategies for Tax-Efficient Investment
Your gilt mutual funds returns can be classified into two types:
1. Dividends
These are added to your income and taxed as per your tax rate.
2. Capital gains
These are gilt fund returns generated after redeeming the investment. Budget 2023 eliminated indexation benefits on debt fund LTCG and also made any profits, regardless of the holding period, taxed according to the investor’s tax slab.
Earlier, holding the investment for a longer period yielded better post-tax returns, but since the change, tax-saving opportunities offered by gilt funds have been limited. It’s best to seek guidance from a tax consultant on this issue. They can help you explore other tax-saving avenues and structure your portfolio in a way that allows you to keep more of your hard-earned money, while still aligning with your financial goals.
Conclusion
Gilt funds are low-risk, open-ended debt funds that invest 80% of their assets in G-secs. Due to their underlying securities, gilt funds eliminate credit risk but can still be impacted by changing interest rates. Generally, the best time to invest in gilt funds is when the interest rates are falling, but you would be wise to seek out advice from an expert before making an investment. They can help you assess the broader economic conditions, interest rate trends, and your specific financial goals and recommend whether or not a gilt fund is the right choice for your portfolio.
Frequently Asked Questions
1. What is the Gilt Fund’s meaning or definition?
To answer what is a gilt fund, we can look into the definition provided by SEBI. Gilt funds are types of debt mutual funds which invest at least 80% of their total assets in government securities across a variety of maturities.
2. What are Gilt Funds in India?
They are open-ended debt mutual funds. Regulated by SEBI, gilt funds invest in G-secs (central and state government securities like long-term bonds, SDLs, and t-bills). Due to their low-risk nature, gilt funds are often preferred by conservative investors. There is no gilt funds full form, as the word comes from “gilt-edged,” which originated in the UK. It refers to high-quality government securities and in India and other Commonwealth countries, it is used to describe government bonds.
3. Should I invest in Gilt Mutual Funds?
As gilt funds are invested in government securities, they come with practically zero default risk. If you are a conservative investor wanting a low-risk option, seeking to preserve the value of your capital, or simply want to diversify your portfolio with more debt allocation, you can consider investing in gilt funds.
4. Which kind of securities does the Gilt Fund invest in?
Gilt funds invest at least 80% in government securities with different maturity periods.
5. What is the appropriate time period to invest in your gilt funds?
Since the government securities held by a gilt fund generally mature in the mid- to long-term, investors with similar horizons should consider investing in them. You should ideally keep an eye on the interest rate and inflation cycles to determine the best time to invest in gilt funds.
