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Gilt Funds in India – A guide to how it works and more

Gilt Funds

Gilt funds are debt instruments that invest primarily in securities issued by Central and State Governments. They fall into the category that gives moderate returns and is considered safe.

What are gilt funds?

Gilt Funds are investment schemes that invest in Government Securities issued by the Reserve Bank of India (RBI) on behalf of the government. These securities have varying maturities – medium to long term. Since gilt funds’ investments are made to the government, they are considered to be safe. The interest for these securities is determined by the RBI, making them low-risk investment options

Long term maturity schemes have high volatility, which means they can be bought and sold quickly because their default risk is almost nil. Gilt funds do not have a risk of non-payment of principal or interest amount. However, Gilt funds are highly exposed to interest rate risk. 

In the short term, gilt funds are considered to be the riskiest among all the debt funds. Gilt funds’ investments are highly vulnerable to interest rate risk. In a falling interest rate scenario, these funds can offer high returns. 

Gilt funds enable investors to invest in government securities. Otherwise, investing in them would require a vast sum. Investors can diversify by investing in gilt funds. These funds earn reasonable returns and help in wealth accumulation over the medium to long term.  

How do Gilt Mutual Funds work?

When a State or Central Government requires funds, they approach the RBI. RBI then accumulates funds from insurance companies or banks and lends it to the government. In exchange, Government securities are issued by the RBI for a fixed tenure. Gilt funds subscribe to these securities. The fund returns it once the security matures, and receives a pay out.

These funds generate returns through interest rate risk. Since the government backs gilt funds, the credit risk is almost zero. Interest rates and prices of government securities are inversely related. In other words, when interest rates rise, prices of government securities fall. It has a direct impact on the performance of gilt funds.

What securities do gilt funds invest?

Gilt funds invest in securities issued by the government of varying maturities. There are two types of gilt funds:

  • Long term gilt funds: These invest in long-dated government securities or bonds. The maturity period is higher than five years and up to even 30 years. Long term gilt funds are riskier and volatile, as they are more sensitive to interest changes. These are best suited for institutional investors. 
  • Short term gilt funds: These invest in short term government bonds and long term bonds with short term residual maturities.

Who can invest in Gilt Funds?

Gilt funds best suit investors who seek the safety of their investments rather than high returns. 

Gilt funds offer moderate returns and ensure capital preservation. In comparison to an equity fund, gilt funds offer better asset quality. In a falling market scenario, gilt funds are effective. The interest rate volatility offers high returns but also exposes the fund to interest rate risk.

Factors to consider as an investor

  • Risks: Gilt Funds are most liquid schemes and do not have any credit risk as the government backs these. However, these funds are exposed to interest rate risk. During a rising interest rate regime, the NAV of a gilt fund drops sharply. 
  • Returns: Gilt funds have a history of earning  relatively high returns . It does not imply that gilt funds guarantee returns. Returns vary based on the interest rates announced by the RBI. In a falling interest scenario, these funds generate high returns. 
  • Investment Horizon: Government securities are issued for medium to long term maturity periods. Gilt funds come with an average maturity of three to five years.  
  • Financial Goals: If the investment objective is to accumulate stable returns with no credit risk, gilt funds are the best available schemes. In a falling market scenario, gilt funds are the safest and right choice to earn good short term returns. 
  • Expense Ratio: Similar to any mutual fund, gilt funds charge management fee, and other related expenses. SEBI has capped the expense ratio at 2.25% for debt mutual funds to protect the interest of investors. The operating cost is fund specific and depends on the fund manager’s investment strategy. 
  • Tax: Taxation of gilt funds is similar to that of debt mutual funds. Capital gains are taxed based on the investment duration. STCG tax would be applied according to the investor’s income tax slab if it were redeemed before three years. Moreover, for long term investments beyond three years, long term capital gains are taxed at 20% with indexation.


Gilt funds primarily have these benefits when compared to other investment avenues.

  1. No credit risk: Since these funds invest in securities that are of high credit quality, there is more or less capital protection guaranteed.
  2. Easy access to government investments: Investing in government securities is beyond reach for retail investors. They need large sums of money. Gilt funds allow retail investors to invest in such securities.
  3. Moderate returns: Gilt funds give moderate risk-free returns in medium to long term. It gives investors a pretty good bargain by balancing risk and return.


Gilt funds have their own set of risks as well.

  1. Increasing interest rate regime: Under an increasing interest rate regime, the returns from gilt funds fall. The inverse relationship between bond prices and interest rates affects the returns of gilt funds.
  2. Low on liquidity: Gilt funds invest in government securities, though they are safe investment options, they are not as liquid as the other securities in the market. It will be difficult for funds managers to switch between government securities.


Similar to other mutual funds, gilt funds also charge a fee for managing the fund. This fee is called the expense ratio. The expense ratio for all debt funds is capped at 2.25% on NAV by SEBI. The fund manager cannot charge more than this from investors. The investors have to be careful while choosing funds. It is better to choose a fund with a lower expense ratio, all things being equal.


Like other mutual funds, gilt funds are also taxed based on the holding period of the investment. Investments redeemed before 36 months is qualified for STCG, and investors are taxed at their slab rates. If redeemed after 36 months, then the investors are taxed at 20% after indexation benefits. 

Gilt Funds in India

2019 was a favorable year for gilt funds as India was under the falling interest rate regime. This explains the double-digit returns from gilt funds. However, interest rate movements are not unidirectional. There are chances for gilt funds to give negative returns as they are highly volatile. Investors have to proceed with caution as the interest rate cuts are not expected soon.

Published on February 10, 2020