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.
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.
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.
Gilt funds invest in securities issued by the government of varying maturities. There are two types of 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.
Gilt funds primarily have these benefits when compared to other investment avenues.
Gilt funds have their own set of risks as well.
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.
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.
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.