​Gilt Funds demystified​​​

Securities issued by the government, known as gilts, are considered to be safer fixed income instruments, as they are sovereign in nature. There is an easier route to invest in these instruments government securities via gilt funds.

What are gilt funds?

Gilts funds are schemes offered by domestic mutual funds wherein they invest the pooled money exclusively in bonds/securities (gilts) issued by the Reserve Bank of India (RBI) on behalf of the government. Hence, their level of safety is similar to or higher than traditional debt instruments. Gilt funds invest in government issued bonds, Treasury bills, state development loans and inflation indexed bonds. The minimum investment amount in gilts is Rs 10,000/- (please refer to the Schemer Information Document / Key Information Memorandum to check the details of minimum application amount) .

Soft interest rate boosts gilt funds

The value of the underlying debt instruments in a fund's portfolio fluctuates on a daily basis (known as market risk) owing to factors such as interest rate movement and liquidity. The price of a debt instrument and interest rates (yields) move in opposite directions, i.e. price of a bond rises when interest rate falls and vice versa.

The net asset value (NAV) of a debt fund scheme replicates the price of the underlying securities. Hence, if interest rate falls, NAV rises. When interest rate eases, gilt funds benefit more than other shorter maturity funds owing to longer maturity of the underlying securities held by the former. Gilt funds would see a higher price change as these securities mature later and, thus, are able to hold on to higher interest rates for a longer time in a falling interest rate scenario.

Gilt funds represented by the CRISIL – AMFI Gilt Fund Performance Index have outperformed the benchmark CRISIL Gilt index and short-term funds. Gilt funds returned 12.07%, 12.48% and 9.78% over 1 year, 3 years and 5 years against 9.43%, 9.86% and 9.92% by short-term funds (represented by CRISIL – AMFI Short Term Debt Fund Performance Index)

Chart 1: Performance of Gilt funds across different time frames

Gilt-Funds-demystified-Chart.jpg

Data as on September 30, 2016, Returns above 1 year are annualized

Historical data shows that gilt funds have the ability to generate higher returns than short-term debt funds in an easing interest rate cycle. During flat rate cycle or high interest rate periods, these funds tend to underperform short-term and money market funds.

Past Performance may or may not be sustained in future

Source: CRISIL Research database

Historical data shows that gilt funds have the ability to generate higher returns than short-term debt funds in an easing interest rate cycle. During flat rate cycle or high interest rate periods, these funds tend to underperform short-term and money market funds.

Table 1: Performance of gilt funds across different interest rate cycles

Market CyclesPeriodCRISIL- AMFI indices Returns (%)
Start DateEnd DateCRISIL – AMFI Gilt Fund Performance IndexCRISIL – AMFI Income Fund Performance IndexCRISIL – AMFI Money Market Fund Performance IndexCRISIL – AMFI Short Term Debt Fund Performance Index
Secular decline in yields in 2000-041-Apr-0030-Apr-0416.4312.027.19NA
Flat to high interest rate period of 2004-0830-Apr-0431-Jul-083.254.206.476.42
Sharp correction in yields in 200831-Jul-0831-Dec-0825.7119.183.855.13
Flat to high interest rate period of 2008-11 31-Dec-0816-Apr-120.884.446.707.08
Post RBI's repo rate cut in April 201216-Apr-1220-Sep-135.957.258.928.34
Post RBI's repo rate hike 20-Sep-1327-Jan-141.971.883.383.53
RBI's status quo 27-Jan-1414-Jan-1516.2513.748.7110.55
RBI's surprise rate cut 15-Jan-1531-Jan-151.050.810.350.48
Repo rate cut in April 2016 and hopes of further cuts 31-Jan-1531-Jul-168.577.718.388.70


Taxation

Investment in debt funds including gilt funds for a period exceeding 36 months qualifies for long-term capital gains tax at 20% with indexation. Indexation helps investors to use inflation to reduce tax liability. For instance, in the three years ended August 2016, gilt funds gave 12.09% returns while the cost inflation index during the period grew by 6.21%. This results in indexed returns for the investor of 5.88% only, sharply lower than actual returns. Investors should, however, note that short-term capital gains tax for period equal to or less than 36 months is subjected to tax as per the income tax bracket. 

ParticularsGilt funds*Bank FDs**
Returns*12.09%9.10%
Cost inflation index growth6.21%-
Returns post indexation benefits5.88%9.10%
Tax rate23.69%^35.54%^
Post tax returns10.75%6.04%
* represented by CRISIL – AMFI Gilt Fund Performance Index (Data as on August 31, 2016), ** for the maturity of 3-5 years (Source: RBI), ^ including 15% surcharge + 3% cess


Suitability

Although gilt funds are credit risk-free since they invest in government securities, they are subject to interest rate risk. As explained, they benefit during falling interest rate scenario and vice versa. Further, even in a falling interest rate scenario, investment in gilt funds will be more beneficial to those who make the first move and are capable of taking tactical calls on interest rate movement. These funds are thus suitable for investors with a higher risk profile and moderate investment horizon of over three years.

Disclaimer : Any information contained in this article is only for informational purpose and does not constitute advice or offer to sell/purchase units of the schemes of SBI Mutual Fund. Information and content herein has been provided by CRISIL Research, a Division of CRISIL Limited, and is to be read from an investment awareness and education perspective only. The views / content expressed herein do not constitute the opinions of SBI Mutual Fund or recommendation of any course of action to be followed by the reader. Investors should consult their financial advisers before taking any investment decision.​


Mutual Fund investments are subject to market risks, read all scheme related document carefully.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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An investor education initiative, SBI MUTUAL FUND.