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Gilt funds are mutual fund schemes that invest in government securities. These securities are issued by the Reserve Bank of India (RBI) on behalf of the Central Government to raise funds. The gilt funds are safe investments as the investments are made to the government. Also, the RBI determines the interest rate for these securities.
Gilt funds with 10 year constant duration are open-ended debt mutual funds. According to SEBI, these funds invest at least 80% of their total assets in government securities where the Macaulay duration for the portfolio is 10 years or more. The objective of gilt with 10 year constant duration mutual funds is to deliver returns by investing in government securities of the highest credit quality. This fund has a negligible risk as the government is liable to pay back the money to its investors.
The RBI changes the repo rate in the market, which affects the interest rate of these funds. Therefore, the gilt with 10 year constant duration mutual funds perform well in the falling interest rate scenario. They could offer higher returns in comparison to other debt funds. Also, its sovereign rating makes it a safe investment instrument. Nevertheless, the returns generated from these funds can fluctuate depending on the pattern of interest rates in the country.
While dealing in gilt funds, the fund’s managers follow a passive approach as they do not actively manage lending duration irrespective of rate changes, and the portfolio duration is maintained constantly at 10 years. Also, the fund manager trades in and out gilt securities with different maturities. This helps them to look for future interest rate movements in the market. Based on this, they invest in short term or long term securities accordingly.
The following are the advantages of investing in gilt with 10 year constant duration mutual funds.
Interest Rate Risk: Gilt funds with 10 year constant duration have a higher interest rate risk than other debt funds. These funds are sensitive to interest rate fluctuations as it invests in government securities with long Macaulay duration. Therefore, these funds are affected when the interest rates rise as the bond prices fall, leading to negative returns.
Gilt with 10 year constant duration mutual funds is suitable for investors looking for long term fixed income investment. Also, these investors seek minimum risk from their investments as the fund invests in government bonds which are the safest instruments. Since these funds invest in government bonds with a fixed duration of 10 years, they may offer higher returns in a falling interest rate scenario.
Moreover, the government securities that the fund invests in has a sovereign rating. Thus, it does not default on the principal and interest payments on government bonds. Investors with low risk tolerance levels can invest in gilt with 10 year constant duration mutual funds.
Investment in gilt funds can help investors diversify their portfolio. Also, it may offer higher returns in comparison to bank fixed deposits. Furthermore, it offers tax-efficient returns compared to fixed deposits for investors in higher income tax brackets. However, as per the Finance Bill 2023, from April 1st 2023, capital gains from gilt funds will be taxed as per the investor’s IT slab rate. Overall, proper financial planning is required before investing in gilt mutual funds.
Some years have been favourable for gilt funds in India due to the falling interest rate regime. For instance, 2019 was a favourable year where the funds gave double-digit returns. However, the interest rates movements are not unidirectional. There are chances of negative returns as they are highly volatile. Therefore, investors have to proceed with caution based on the interest rate cuts.