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 ensure safety
In India Gilt Funds are investment schemes that invest in Government Securities. The Reserve Bank of India (RBI) on behalf of the government issues these securities. These securities have varying maturities – medium to long term. Since gilt mutual funds’ investments are made to the government, they are considered to be safe. The RBI determines the interest for these securities, 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. These funds do not have a risk of non-payment of principal or interest amount. However, there is a higher exposure to interest rate risk.
In the short term, they 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.
It enable investors to invest in government securities. Otherwise, investing in them would require a vast sum. Investors can diversify by investing in it. These funds earn reasonable returns and help in wealth accumulation over the medium to long term.
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, RBI issues Government securities 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 it, 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 its performance.
In India Gilt funds invest in securities issued by the government of varying maturities. There are two types of mutual funds in India:
It best suit investors who seek the safety of their investments rather than high returns.
It offer moderate returns and ensure capital preservation. In comparison to an equity fund, it offer better asset quality. In a falling market scenario, these are effective. The interest rate volatility offers high returns but also exposes the fund to interest rate risk.
Gilt funds primarily have these benefits when compared to other investment avenues.
Gilt funds have their own set of risks as well.
Gilt funds also charge a managing fee namely 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.
Like other mutual funds, its taxation depends 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.
2019 was a favorable year for gilt funds in India due to the falling interest rate regime. This explains the double-digit returns from these mutual funds in India. However, interest rate movements are not unidirectional. There are chances of negative returns as they are highly volatile. Investors have to proceed with caution as the interest rate cuts are not expected soon
Taxation on mutual funds is a complex topic. Taxes paid on your mutual fund investments vastly depend on factors such as what kind of funds you have invested in, the duration of your investment, which income tax slab you belong to and so on.